What Are The Markets Facing?

On Monday, Eurostat estimates for Euro-zone CPI are expected to show that inflation accelerated at an ever faster clip of 3.9 percent in June. If CPI is indeed confirmed at this pace, the figure would match the 16-year high. While much of the rise in price pressures for Europe, and for that matter, much of the other world’s economies, are due to rocketing energy and food costs, the news would only underpin European Central Bank President Jean-Claude Trichet’s already hawkish bias. Indeed, Mr. Trichet, whose primary mandate is to maintain price stability, said after the most recent policy meeting that they would consider hiking rates the following month, and that some policy makers had actually wanted to tighten monetary policy in June. As a result, the ECB is widely expected to hike rates by 25 basis points to 4.25 percent at their next meeting on Thursday. However, a weaker-than-expected reading could lead speculation of an imminent hike cool, as the news would give Mr. Trichet leeway to put off increasing rates until later in the summer.

Bonds – 10-Year German Bund Futures

Bund futures have recovered quite a bit from the June 2007 low of 109.66, as market-wide risk aversion leads government debt higher. Looking ahead to next week, Euro-zone CPI estimates for June are expected to show yet another sharp rise, which could weigh Bunds back below 111.00 as the markets anticipate a rate hike by the European Central Bank on Thursday. However, if traders continue to flee risky assets in favor of save havens like government bonds, Bunds could continue to climb to target trendline resistance at 112.00.

FX – EUR/USD

From a long-term perspective, EUR/USD continues to trade within a wide range of1.5350 – 1.5800, as the US dollar consolidates across the majors. However, the pair remains very much within an uptrend, as EUR/USD bounced from trendline and 100 SMA support just a few weeks ago. Looking ahead to Monday, Euro-zone CPI is expected to rise 3.9 percent in June from a year earlier, which could help EUR/USD break above resistance at 1.5800. Indeed, this data is especially important ahead of the European Central Bank’s rate decision on Thursday, when ECB President Jean-Claude Trichet is anticipated to hike rates to 4.25 percent. However, lower than expected CPI figures would shift the market’s focus to the Euro-zone’s clear economic slowdown and may lessen speculation of an imminent rate increase, which would lead the pair to tumble toward the 1.5630 support level.

Equities – Xetra DAX Index

Germany’s Xetra DAX index experienced a slow day on Friday as uncertainty clouded the markets and inflation worries persist, as crude oil rocketed to a fresh record above $142/bbl on Friday. In addition, participants await a much anticipated rate hike by the European Central Bank, which could sap confidence in the economy as many view monetary policy as already being restrictive. Looking ahead, Monday’s Euro-zone CPI release could add additional volatility in the markets, as initial estimates are expected to show that the index increased 3.9 percent from a year earlier. If figures are released in line with or more than expected, the index could pull back toward the January lows of 6,384. However, a softer-than-anticipated release could help the index consolidate above 6,400.

Terri Belkas is a Currency Strategist at FXCM.