Has the dollar slide run its course?
The US CPI inflation and core inflation figures are in focus on Friday as they are set to drive the price action in dollar FX pairs and equity indices to an extent.
A month ago the Bureau of Labor Statistics reported the Consumer Price Index was flat in June from the prior month, with inflation holding at 1.6% year-over-year. Core inflation (the index for all items less food and energy) rose 0.1% in June, which was its third straight increase of this amount.
Market participants will be looking for any significant signs of an uplift in inflation beyond what is a pretty sedentary pace at present. Acceleration in inflation would boost the case for the Federal Reserve to raise interest rates again. However any easing back in the pace of price growth would chuck a spanner in the works and could spark further dollar weakness.
The Fed thinks inflation is not going to accelerate as quickly this year as previously. Policymakers have downgraded their forecast for core inflation in 2017 from 1.9% in March to just 1.7%, a sign that they are clearly concerned about disinflationary pressures taking a grip. A lack of wage uplift despite the high employment rate has policymakers and economists scratching their heads.
The FOMC has lately conceded that it is ‘monitoring inflation developments closely’, which could be a signal that the central bank is starting to have doubts about whether the strong labour market is enough to get inflation to its target rate. A low labour force participation rate (which has fallen from around 66% pre-crisis to below 63% today) creates a lot of extra slack that keeps a lid on wages and inflation.
Current market odds for another rate hike this year are about 50-50, according to the CME Group’s FedWatch tool.
The dollar suffered at the hands of a resurgent euro over the summer but has come back a touch after some risk-off selling turned EURUSD south again.
EURUSD has been on a tear since April, gaining more than 12% before handing back those gains in the last week. Currently EURUSD is holding above the 50-day moving average but there are signs of convergence with this and the trend line since April.
The last two CPI releases have produced some decent moves in the greenback. The two charts below show the moves in EURUSD on June 14th and July 14th when the figures were released at 13:30. Both resulted in the euro jumping half a cent against the dollar in fairly short order.