CPI (YoY) (FEB) (12:30 GMT; 08:30 EST)
Expected: 4.2%
Previous: 4.3%

CPI Ex F & E (YoY) (FEB) (12:30 GMT; 08:30 EST)
Expected: 2.4%
Previous: 2.5%

What Are The Markets Facing?

February’s US Consumer Price Index is expected to show inflation easing to 4.2%. This will be welcomed news by the Federal Reserve, as its dovish posture has meant that it has largely ignored inflation as a threat. The Central Bank’s recent infusion of liquidity was a clear sign that their easing policy hasn’t produced the expected results. Many expect that Chairman Bernanke will look to continue his aggressive policy in attempts to avoid a recession and will cut rates by 75 points at the next meeting. However, If the report surprises with higher than expected inflationary pressure the Fed may begin to consider price stability an issue and move less aggressively in lowering interest rates. Alternatively, if inflation looks to be under control then the Fed will be able to maintain its current stance in stimulating the US economy and avoiding a severe downturn.

Bonds – 10-Year Treasury Note Futures

Treasuries continue to find support as risk aversion was back in vogue after traders deemed the Fed’s recent liquidity infusion as inconsequential. The recent failure of the Carlyle fund has left traders wondering how many more victims of the subprime crises are yet to reveal themselves. Therefore, we may see the current upward trend extend, especially after recently breaking through the psychological, resistance level of 120. Expectations are that the upcoming CPI reading will ease and reduce inflation fears, thus allowing the Fed to continue to cut rates as expected. However, a hotter than expected inflation index may encourage the Fed to reduce the amount of their next rate cut, especially, after their recent intervention.

FX – EUR/USD

The Euro continues to assault the dollar and breaking new barriers daily. Its recent breach of the 1.56 level has it coming up against technical resistance levels and concerns that further appreciation may lead to a runaway rally. The upcoming CPI reading is expected to show inflation easing, which will continue bearish dollar sentiment. As the Fed will have a continued license to cut interest rates in an effort to rescue a declining economy. Downside risks to the dollar remain as economic growth, loose monetary policy, and capital outflows continue to be the most important factors behind the currency’s weakness. However, If the report surprises and price stability becomes a problem for the Federal Reserve, Chairman Bernanke may need to consider how future Fed easing may contribute to inflationary pressure. Any indication that the Fed will deliver anything less than a 75 point rate cut next meeting may be enough to rally the oversold dollar and sent it back towards support at 1.5150

Equities – Dow Jones Industrial Average

The DJIA gave back some of it s gains Wednesday declining 0.38 percent as exuberance over the Federal Reserve’s liquidity injection plan faded. Oil prices spiked to a new record of $110, putting a further dent in U.S. economic prospects in spite of data showing U.S. stockpiles had risen. Friday’s CPI report may show that despite high oil prices price stability month-over-month is still not a major problem. Both headline and core inflation figures are expected to decline from January. Moderate price stability may indicate that the consumer’s purchasing power is being eroded less than expected, giving the Federal Reserve more room to move rates lower.

Terri Belkas is a Currency Strategist at FXCM.