Why the U.S. Dollar Can't be Saved by CPI Alone

The most important event risk for the U.S. dollar this week is Friday's inflation report but consumer prices alone won't be enough to save the dollar.  USD/JPY is falling because of geopolitical risks and less hawkish comments from Federal Reserve officials.  This morning FOMC voter Dudley joined the chorus of U.S. policymakers expressing concern about low inflation.  He said it is going to take some time for inflation to rise to 2% as the weaker dollar affects import prices.  He believes that year over year price measures will be depressed for a while and that the economy may be a bit more sluggish on the margin. He also felt that sluggish productivity could dampen wage growth despite job gains.  As one of the main drivers of Fed policy, Dudley's cautious views confirm that the central bank is in no rush to raise interest rates especially after this morning's producer price report.  Prices took an unexpected -0.1% dip in the month of July, causing the year over year rate to slow to 1.9% from 2% and jobless claims rose to 244K from 241K.  The drop in PPI signals potential weakness in CPI but even if consumer prices tick higher like economists anticipate, it won't be enough because the Fed doesn't feel good about inflation and more importantly, geopolitical tensions between the U.S. and North Korea continue to grow. So until the threat of war diffuses, USD/JPY could have a difficult time responding to positive data.  With that in mind, stronger CPI could send pairs like EUR/USD to 1.1700 as it exacerbates the pressure on high beta currencies that have been hit hard by risk aversion.  

The worst performing currency today was the New Zealand dollar which fell hard after Reserve Bank of New Zealand Governor Wheeler raised the possibility of currency intervention. What's interesting about his comment is that it was not made during his post monetary policy meeting press conference but rather during his testimony to Parliament.  As expected the RBNZ left interest rates unchanged at 1.75%. They expressed concerns about inflation and the possibility of a further decline in coming quarters.  During the press conference, Wheeler didn't say much. He expressed confidence that the economy will expand more than 3% over the coming years, said house price inflation could pick up after the election and a lower NZD would help.  But he used much stronger words during his testimony to Parliament, he said he would like to see a lower exchange rate, talked about how currency intervention is always an option and how they are always assessing the criteria.  Shortly after, Assistant Governor McDermott went one step further by confirming that the RBNZ changed NZD language to signal unease and this is the first step towards possible intervention.  So while NZD bounced off its lows during the NY session, it remains a sell on rallies against most major currencies regardless of how tonight's business PMI index fares.  The Canadian and Australian dollars also ended the day lower although their moves paled in comparison to NZD.  Canada's new housing price index slowed, oil prices unwound its earlier gains while consumer inflation expectations in Australia eased.    

The euro ended the day unchanged and its resilience continues to be a testament to the market's demand for the currency.  Sterling rose above 1.3000 in the hours that followed the country's industrial production and trade balance reports.  Manufacturing activity rebounded 0.5% in the month of June, which was much stronger than the market's 0.1% forecast and that upside surprise completely overshadowed the lack of improvement in manufacturing production index and the trade balance. Yet by the end of the European trading session, sterling sank from its highs as the data failed to draw away from the sluggish growth in the economy and the uncertainties that lie ahead.