What Are The Markets Facing?

The US headline consumer price index for the month of June is expected to rise 0.7 percent upon release at 8:30 EDT, while the annual rate of growth is forecasted to jump to a nearly 3-year high of 4.5 percent. A bulk of the increase will likely be the result of food and energy price gains, especially as oil hit a fresh record above $140/bbl. Meanwhile, core CPI is anticipated to show a mild 0.2 percent rise for the month, which would leave the annualized reading at 2.3 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 figures are in line with expectations, Treasuries, the US dollar, and US stock markets may simply trade quietly ahead of the release of the minutes from the FOMC meeting on June 24-25 at 14:00 EDT. During that meeting, the Fed left rates steady, though one member – Richard Fisher – actually voted for a rate increase. The key thing to watch for in the release of the minutes is the commentary amongst the FOMC members regarding inflation, especially in light of record oil prices. Currently, fed fund futures are betting that the Fed will leave rates steady until year-end, but hawkish rhetoric could lead traders to price in a chance of rate increases. However, if the FOMC members brush off the inflation factors and focus instead on shaky financial market conditions and the significant US economic slowdown, futures may start to become more aggressive in pricing in either steady rates or even a cut, which could weigh heavily on the US dollar.

Bonds – 10-Year Treasury Note Futures

Treasuries surged toward resistance at the 100 SMA on Tuesday as Bernanke’s commentary sounded bearish on the US economy, and looking ahead to Wednesday, the release of US CPI provides ample event risk for the contract, as they are anticipated to show a rise in prices. We’ve seen that the US bond markets and the greenback have been very jittery on inflation-related news, so if CPI does not meet expectations dead-on, volatility could pick up substantially in both markets. Hot CPI numbers could weigh Treasuries down below 115, but on the other hand, weak CPI figures could send the contract surging above resistance at 116-03.

FX – EUR/USD

EUR/USD hit a new record high on Tuesday morning of 1.6038, but subsequently backed off as the US dollar staged a recovery on the back of commentary by Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson. Looking ahead to Wednesday, the release of US CPI provides ample event risk for the US dollar, as it is anticipated to show a surge in prices thanks to rocketing commodities. We’ve seen that the US bond markets and the greenback have been very jittery on inflation-related news, so if CPI does not meet expectations dead-on, volatility could pick up substantially in both markets. Given the jump in energy and food prices during the month of June, there are upside risks for the headline CPI numbers and if the indexes are stronger-than-forecasted, EUR/USD could plunge toward support at 1.5825. On the other hand, softer-than-expected figures could send EUR/USD rocketing up for another test of 1.60, if not a break above, as traders cut back expectations that the Federal Reserve will implement a rate hike by year-end.

Equities – Dow Jones Industrial Average

On Tuesday, the DJIA closed below 11,000, though price is still holding above a rising trendline that dates back to April 2005. Indeed, traders should keep an eye on financial market news, as indications of distress amongst financial institutions could trigger widespread sell-offs in the global equity markets (and for that matter, forex carry trades). Looking ahead to Wednesday, US CPI numbers could shake up the DJIA. The indexes are anticipated to show a rise in prices, but if the CPI report reflects weaker-than-expected price growth, the DJIA could bounce back above 11,000. On the other hand, indications of mounting inflation pressures in the US economy could weigh the DJIA down for a break of critical support toward the 2006 lows near 10,700.

Terri Belkas is a Currency Strategist at FXCM.