UK core CPI expected to fall to a 20-year low, FOMC in focus

European markets had a much better session yesterday driven by a dose of retail therapy, helping to push the FTSE100 to its best levels this month, and while US markets also finished the day higher, a late selloff into the close tempered gains there.

This late sell-off from the intraday peaks in the US could well mean that European markets may well open a little mixed this morning, with a slight downward bias, as we look ahead to today’s long-awaited Federal Reserve rate meeting.    

Before that we have the latest UK CPI numbers. Last month’s UK inflation numbers saw CPI rise sharply in July to 1%, with core prices hitting 1.8%, a twelve-month high, driven largely by a rise in fuel prices and clothing costs. The easing of lockdown restrictions also had something to with the sharp rise in prices, as businesses attempted to recoup lost income as a result of the shutdown. We already have anecdotal evidence that hair salons hiked prices to offset the loss of income as a result of lockdowns, so this is likely to have played a part in the sharp rise in prices. This is likely to be a temporary phenomenon, given concerns about rising unemployment which are expected to see households curtail their spending.

We’ve already started to see the early signs of the unemployment rate starting to edge higher, and with the furlough coming to an end next month and already being tapered, this deflationary wave is likely to get worse in the short term.

Expectations for August CPI are for a sharp decline to 0.1%, with core prices sliding back to 0.5% from 1.8%. This would be the lowest level for core prices since the year 2000.   

No changes in policy are expected at today’s Fed meeting, with the recent speech by Fed chair Jerome Powell at the Jackson Hole virtual symposium still fresh in the memory.

His comments that the Fed was now looking at implementing a new policy of AIT or “average inflation targeting”. This means that central bank policymakers would be prepared to tolerate prices rising above 2% for periods of time to compensate for other periods of time when inflation is running below target. This raises a number of key questions, firstly in how you determine the average benchmark, given the Fed has struggled to get anywhere near its existing 2% target for most of the last 20 years now.

If an average were taken of core PCE since the turn of the century, the average would be somewhere closer to 1.5% than 2%, with the Fed only hitting its current 2% target twice in the last decade, during a short period in 2012, and for most of 2018.

Another question, revolves around how successful this type of policy would be given that this isn’t much different to what central banks have been doing for the past 12 years, with the only difference now being that central banks are openly acknowledging that this is the direction they’ve already been leaning towards.   

All these comments have done is merely confirm that the Fed is less concerned about its inflation mandate than it is on the employment component. In reality the Fed is somewhat of a hostage to events, whether it be a second wave or political gridlock over a second stimulus package.

In recent comments a number of Fed officials have been more vocal about the prospect of more aggressive policy action. Lael Brainard in particular has been at the forefront of the recent change in policy, while Atlanta Fed president Raphael Bostic went even further saying that the Fed was trying to do the best it can to support those who don’t have a position in the stock market.

This week’s meeting is likely to be geared towards refining the parameters of this new policy, without fundamentally altering the pre-election dynamics of the upcoming US election.

Before today’s Fed meeting, we’ll get a good look under the hood when it comes to the health of the US consumer, with the latest retail sales report for August. While July retail sales painted a mixed picture of the US consumer, showing a monthly gain of 1.2%, slightly below expectations, the upward revision to June from 7.5% to 8.4% more than made up for that, while the control group measure which is used to calculate GDP rose by more than expected to 1.4%.’

All in all, the numbers were all over the place, which tells you little about the overall state of the US economy, apart from that it is continuing to recover from the effects of the shutdown in April, albeit on a patchier scale than expected.

This makes today’s August report all the more important, and while the resilience of the labour market ought to bode well for the August retail sales numbers, the expiry of the $600 a week unemployment top-up could well adversely impact spending patterns for this month, particularly since consumer confidence fell sharply to 84.8, its lowest level since mid-2014. This could be the canary in the coal mine for early signs of a slowdown in US consumer spending. Expectations are for a gain of 1.3% which could be a touch optimistic.

EUR/USD – yesterday saw another failure at the 1.1900 area with the euro slipping back again. This remains a key barrier while above the early August neckline support. This continues to call into question current momentum, with a break below 1.1720 suggesting a move towards 1.1500.  Above 1.1920 retargets the 1.2000 area.  

GBP/USD – the pound has continued its tentative recovery off the 1.2750/60 area and 200-day MA support. Despite the rebound we haven’t as yet been able to move above the 1.2920/30 which we need to overcome to retarget the 1.3030 level. The risk remains for a move lower through 1.2730 towards the 1.2500 area, while below the 1.3030 area.  

EUR/GBP – has continued to slip back but we need to see a move through 0.9170 to suggest the top is in. While above 0.9170 the risk remains for a move towards the 0.9400 area. A move back below the 0.9170 area opens up the prospect of a move back to the 0.9080 area.

USDJPY – currently looking sloppy with the risk we could see a break below 105.00 towards the 104.20 area. We need to see a move back above 106.20 to retarget the 107.00 area.

FTSE100 is expected to open 20 points lower at 6,085.

DAX is expected to open 18 points higher at 13,235.

CAC40 is expected to open 3 points lower at 5,065.