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What does soft CPI mean for FOMC and USD?

Inflation is cooling in the U.S. and the evidence sent the greenback tumbling against all of the major currencies.  Consumer prices grew 0.3% in the month of August down from 0.5% in July. Economists anticipated the decline but the magnitude was larger than expected especially in core prices. The monthly core inflation rate rose only 0.1%, which drove the year over year rate down to 4% from 4.3%. This marked the weakest increase in core prices (which excludes volatile food and energy costs) since February. For the past few months, the Federal Reserve has viewed higher inflation as transitory. While their view has been met with skepticism inside and outside of the central bank, today’s report reinforces Chairman Powell’s steadily cautious approach. The Fed passed on the opportunity to signal taper in August and now it looks like they could do it again in September.
 
Even before today’s CPI report, there was a lot of skepticism about how clear the Federal Reserve would be about taper at this month’s meeting. The one two punch of slower job growth and inflation could push policymakers to punt any taper moves to November. The nose dive in Treasury yields and sell-off in the U.S. dollar are signs that investors are bracing for the worst. With economists looking for retail sales to fall for the third time in four months, the U.S. dollar should remain under pressure and extend its slide against the Japanese Yen, Swiss Franc, euro and British pound.
 
Inflation reports are due from the U.K. and Canada tomorrow. Unlike the U.S., price pressures in the U.K. remain strong in the manufacturing and service sectors according to PMIs. Canada on the other hand saw price growth slow in the manufacturing sector. Sterling ended the day unchanged against the greenback despite slightly better than expected labor market numbers.  The total number of jobs created was more than expected in June with the unemployment rate dipping slightly. However with a furlough program in place until the end of the month, it is difficult to tell exactly how well the labor market is doing. 
 
There was a lot of volatility in the Canadian dollar during the NY session. USDCAD dropped to 1.2600 after the U.S. CPI report but verticalized shortly after to end the day in positive territory as oil prices and stocks reversed lower.  If inflation cools in Canada like we expect, USD/CAD which has been trading in a tight range could break to the upside. The U.S. dollar is weak but USD/CAD is more sensitive to risk flows than the market’s appetite for U.S. dollars.
 
Euro ended the day slightly higher but has for the most part been unable to muster sustainable gains since the European Central Bank monetary policy announcement. The Australian and New Zealand dollars ended the day lower. Although Queensland avoided a fresh lockdown, the COVID-19 situation in the country remains grim. Reserve Bank of Australia Governor Lowe spoke last night and while he confirmed that they would continue with their plans to taper, he does not see an interest rate hike until 2024. This week’s labor market report will should show how badly the lockdown impacted the economy but Lowe believes that the setback is temporary and will simply delay not derail the recovery. 
 
New Zealand consumer confidence numbers are due for release tonight and with Auckland still in lockdown, sentiment is expected to fall. Like the U.S., price pressures appear to be easing because food inflation slowed from 2.8% to 2.4% in August. The New Zealand dollar is very sensitive to risk appetite which is one of the primary reasons why NZD did not rally on U.S. dollar weakness.

Author

Kathy Lien

Kathy Lien

BKTraders and Prop Traders Edge

Having graduated New York University’s Stern School of Business at the age of 18, Ms. Kathy Lien has more than 13 years of experience in the financial markets with a specific focus on currencies.

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