Import Price Index (MoM) (NOV) (13:30 GMT; 08:30 EST)
Expected: 2.0%
Previous: 1.8%

Import Price Index (YoY) (NOV) (13:30 GMT; 08:30 EST)
Expected: 11.0%
Previous: 9.6%

How Will The Markets React?

With the US dollar still trading relatively weak against the majors, there are concerns that import price inflation will rise significantly. The prospect of increased price pressures only compounds the problems that the Federal Reserve already faces as they’ve slashed the federal funds rate by 75 basis points since September in an attempt to forestall a broad-based economic recession and a crash in the US stock market, and they are expected to cut another 25bp on Tuesday afternoon. However, none of these risks appear to have diminished yet and fed fund futures continue to price in multiple rate cuts next year. What about that pesky inflation issue? Won’t more accommodative monetary policy only fan price pressures? This topic may come to the forefront on Wednesday as the US import price index is expected to have risen 2.0 percent in November from the month prior while the index is also forecasted to have surged 11.0 percent from a year earlier – the sharpest rise in over twenty years. Such a result will only increase anticipation for the CPI release at the end of the week, which is also very likely to highlight the rising inflation pressures in the US economy, which effectively leaves the Federal Reserve’s hands tied. Will they continue to attempt to stave off a collapse in the economy and equity markets while abandoning their price stability mandate, or will they leave monetary policy unchanged to give themselves more time to plot their next move? Unfortunately for traders, the reaction in the fixed income, FX, and equity markets could be skewed in the aftermath of the December 11 FOMC rate decision.

Bonds – 10-Year Treasury Note Futures

Treasuries have eased below support at the 38 percent retracement of the latest rally and an ascending trendline near 112-16. While the contracts could stand to gain on Tuesday's FOMC rate decision, immediate resistance is at 112-25, which could limit gains. On the other hand, if the FOMC’s policy statement signals that the bank may not cut rates again in January, Treasuries could actually be weighed down by the end of the day. On Wednesday, the release of the US import price index could send the contract plummeting as a sign that inflation may prevent the Federal Reserve from cutting rates further. Extreme moves lower may look to target the 111-00 level.

FX – EUR/USD

EUR/USD has continued its rally since running into trendline support at 1.4525, as traders look ahead to the FOMC meeting on Tuesday. The meeting is widely expected to yield at least a 25bp cut to the federal funds rate, if not a 50bp cut. Any rate cut will serve to weaken the greenback at first, but the currency could rebound later if the policy statement suggests that a rate cut is not in store next month. However, traders should also consider the outside possibility that the FOMC may not cut the federal funds rate at all and will only decrease the discount rate. While the chances of this are small, the impact the decision would have on the dollar is significant as the markets consider a 25bp cut a sure thing.

On Wednesday, the US import price index is expected to rise significantly, which could bring the inflation issue to the forefront once again. Indeed, with price pressures steadily building, the FOMC may not have the luxury of cutting rates further in January without undermining their price stability mandate. Under normal circumstances, the US dollar would perhaps rally on the news, but if the FOMC rate decision or policy statement is remotely surprisingly, EUR/USD price action could be skewed by sentiment related to the meeting. Nevertheless, resistance looms above near 1.4800/70, which could mark a turning point for any additional EUR/USD gains. Meanwhile, support sits below at 1.4600, with sharp declines targeting trendline support near 1.4550.

Equities – Dow Jones Industrial Average

The Dow’s rally may be coming close to an end, as resistance looms at 13,850. Indeed, expectations of a rate cut by the FOMC on Tuesday have fueled gains in the US equity markets, but where they go thereafter depends not only on the policy decision, but also the policy statement. A 25bp cut would support the Dow temporarily, while a 50bp cut could serve to fuel sharp gains for the index. However, how long those gains last depends on how severe the FOMC judges the strains in the financial market to be. Furthermore, whether equity market bulls stay in the game may depend on if the FOMC suggests that they will not cut rates again in January by noting that upside inflation risks outweigh downside risks to growth. The worst case scenario for the Dow is if the FOMC leaves the federal funds rate unchanged, as the markets essentially consider a 25bp cut a sure thing. Such a decision could allow the Dow to plummet back down towards 13,500.

Furthermore, on Wednesday, the release of the US import price index may only reiterate any hawkish sentiment in the FOMC policy statement, as inflation pressures may leave the bank no room to cut rates further without completely abandoning their price stability mandate. As a result, the data on Wednesday could drive the Dow even lower, with a break of the 13,500 level targeting the 200 SMA at 12,275.

Terri Belkas is a Currency Strategist at FXCM.