The Federal Reserve’s conundrum: stubbornly low inflation

Good morning, traders  are  doing little more than  picking up the pieces from  Friday dismal US CPI while searching for the next catalyst

The Federal Reserve’s conundrum: stubbornly low inflation

US equity markets closed the week out on a high note while US Treasury Yields sagged after the US CPI continued to miss market expectations. And despite Core CPI missing for the seventh consecutive month and taxing the Fed’s transitory inflation argument, Dr Yellen continued to tow the FOMC line during the weekend IMF meetings. Dr Yellen said “my best guess is that these soft (inflation) readings will not persist” and that “with the ongoing strengthening of labour markets, I expect inflation to move higher next year”.

Inflation Conundrum

The Feds inflation conundrum is alive and well. And given their ingrained stance regarding inflation, in the absence of any discernible uptick in core or wages, the dollar should continue to struggle as the muted inflation prints might be raising the risks of slower action by the Fed.

But given a very light economic calendar this week, dealers will remain single-mindedly focused on Fed chair nomination and tax reform headlines for short-term direction, which should keep the dollar bulls hopes somewhat alive.

ECB

Mario Draghi kept it very dovish into weeks end echoing his recent comments and delivering an unambiguous signal to markets that while the ECB is likely to address the QE program in October, forget about a rate hike anytime soon.

FED Speak

The market is always agog about in “Fed speak” more so after a miserable inflation print. So we should expect Chair Yellen deliveries this week to come into focus. While her comments are unlikely to affect the December Rate hike scenario, the markets will key on her emphasis regarding inflaton do determine if any more uncertainty is entering the picture. But based on her weekend IMF comments, she seems emphatical that inflation will flare up soon.

Asia EM FX

Markets have apparently found a happy medium after all the tax reform and US economic data had markets pricing in a quicker pace of Fed normalisation, underpinning the broader USD. But with the Feds inflation conundrum alive and well the market will likely pivot to the Global Growth storyline and its positive implication for regional risk. Uncertainties around US inflation should keep the dollar grounded, and traders should prefer to sell the greenback on rallies with both CNH and MYR most likely to outperform on the dovish Fed narrative.

EURO

Draghi’s dovish overtones are weighing on sentiment despite the downside miss on US CPI. Euro bulls are tentatively re-engaging in early APAC but looking over their shoulder for Tax Reform and New Fed Chair headlines.

Japanese Yen

US CPI fallout is weighing on sentiment, but the market is still searching for an election buzz. But with the risk rewards fading for the long dollar positions I suspect the short term players are prepared to sell USD on rallies.

Australian Dollar 

With commodity prices basing and Fed policy beyond 2017 wobbling the Aussie could extend gains early in the week.