US Consumer Price Index (JAN) (13:30 GMT; 08:30 EST)
Expected: 210.893
Previous: 210.036

FOMC Meeting Minutes (JAN) (19:00 GMT; 14:00 EST)
Expected: Dovish
Previous: Dovish

What Are The Markets Facing?

Upcoming US economic data is highly anticipated, as the news will give insight into the status of inflation as well as the Federal Reserve’s stance. First, the headline consumer price index for the month of January is expected to rise 0.3 percent and push the annual rate of growth up to 4.2 percent. A bulk of the increase will likely be the result of food and energy price gains, especially as oil hit a record high of $100.09/bbl on January 3. As a result, core CPI is anticipated to show a milder 0.2 percent rise for the month and an unchanged annualize reading of 2.4 percent. However, if any of these figures surprise to the upside or downside, the markets will respond accordingly and the moves could be dramatic. On the other hand, if the CPI reports are released in line with expectations, Treasuries, the US dollar, and US stock markets may simply trade quietly until the release of the FOMC January meeting minutes. During this last meeting on January 29-30, the FOMC cut rates by 50bp to 3.00 percent, just a week after slashing the fed funds rate by 75bp at an emergency meeting on January 22. As a result, it’s rather clear that the instability in the financial markets and the downside risks to growth were of major concern at the time, and a pronounced focus on these issues will lead investors to aggressively price in another round of rate cuts in March. On the other hand, suggestions that the FOMC’s previous policy actions may be enough to support the economy for now, or indications that the central bank is becoming increasingly worried about stoking inflation with their rate cuts could lead to a sharp pullback in Fed rate expectations.

Bonds – 10-Year Treasury Note Futures

Treasuries continue to look heavy, but in order to confirm that a more bearish move is underway, a break below the bottom of the range that has formed since late January at 115-24 is necessary. Wednesday could bring about choppy price action for the contract, as a pick up in US CPI in the morning could weigh on Treasuries, while the FOMC meeting minutes in the afternoon may propel them towards major resistance is 116-24. Generally, the FOMC minutes tend to be a bit more market-moving, which may leave Treasuries trading quietly for most of the day. On the other hand, surprising CPI figures could see volatility ensue throughout the trading session.

FX – EUR/USD

The EUR/USD pair has shown further consolidation after reaching a high of 1.4966 on November 23rd. and the pair currently looks to be on the upswing as Technical Strategist Jamie Saettele’s recent Elliot Wave analysis supports the case for a climb towards 1.50. The US dollar pairs face major event risk ahead of the US CPI report due Wednesday. A Bloomberg News poll of economists reflects consensus estimates for headline CPI to accelerate 4.2 percent from a year earlier while the core figure is anticipated to grow 2.4 percent from a year ago. While the inflation numbers may contradict the Federal Reserve’s loose monetary policy stance, the minutes from the last FOMC meeting – also scheduled to be released on Wednesday - will most likely underpin the market’s expectations for another 50bp rate cut to 2.50 percent in March. Indeed, the central bank has proven to be highly concerned about the downside risks to economic growth and the instability in the financial markets, and the FOMC minutes aren’t likely to suggest that the committee’s bias has changed. As a result, while the Fed’s current stance gives it little wiggle room if the CPI reports suggest that inflation is becoming a problem, the EUR/USD pair may ultimately continue to climb towards 1.50.

Equities – Dow Jones Industrial Average

Last week saw the Dow experience extreme volatility as traders tried to decipher Warren Buffet’s bond insurer proposal, Ben Bernanke’s negative comments, and contradicting economic data, as retail sales proved to be stronger than expected and the consumer confidence and New York manufacturing indexes fell to multi-year lows. The Fed remains extremely dovish, despite the fact that they just cut rates by 150bp in January, as they haven’t achieved their goal of adding sufficient liquidity to the market. Recent comments from Fed Chairman Bernanke, who noted “it is important to recognize that downside risks to growth remain, including the possibilities that the housing market or the labor market may deteriorate to an extent beyond that currently anticipated, or that credit conditions may tighten substantially further,” illustrate this point. Additionally, fear is growing that the recent run of subprime related write-downs is just the beginning, as bond insurers are at risk of getting downgraded and several leveraged loans are at risk of defaulting. Although stocks are expected to start the week on a positive foot, with Wal-mart reporting better than expected earnings, there is potential for the FOMC meeting minutes to heighten investor fears and increase downside potential for the Dow as they spell out the Fed’s concerns. While CPI is expected to tick higher, it may be a non-event as the Fed has shown that jump starting the economy remains their focus. Nevertheless, it has become a topic of conversation and several regional Federal Reserve Bank presidents have come out and expressed concern on the issue. As a result, if the Fed paints a rosier than expected picture, the markets may start pricing in a US recovery and help lead US equities to rally.

Terri Belkas is a Currency Strategist at FXCM.