US Dollar: CPI Forecasted to Fall by Most on Record, But Fed Meeting Minutes May Steal the Show

The US dollar held strong on Tuesday as the currency continues to consolidate within an increasingly tight range. However, the US dollar initially slipped on the release of the US Producer Price Index (PPI) as the report told two different stories about the inflation picture in the US. The headline reading plummeted by the most on record during October, helping to drag the annual rate of growth to a 1-year low of 5.2 percent from 8.7 percent. However, the Federal Reserve may find it somewhat disconcerting that PPI excluding food and energy actually rose 0.4 percent during the month, pushing the annual rate to a nearly 20 year high of 4.4 percent from 4.0 percent. Looking ahead to Tuesday, the US Consumer Price Index (CPI) is anticipated to have plunged 0.8 percent during the month of October, which would mark the sharpest drop since 1949, while the annual measure is projected to slip to a 5-month low of 4.1 percent. Like the release of PPI, the headline CPI results should be weighed down by volatile food and energy prices given the drop in commodities since the summer. However, if the core readings that exclude these factors fail to fall as well, there may be an increase in concerns that the Federal Reserve will not move forward with additional rate cuts in December.

That said, the release of the minutes from the Federal Open Market Committee's October meeting could garner even more attention than the US CPI figures as they will give clearer insight into the Fed's bias going forward. The thing to watch with the minutes is to see how much the FOMC focuses on downside risks to growth and declining inflation expectations. Since risk trends have been the primary driver of price action lately, it will likely be best to gauge the stock market’s reaction as a pessimistic turn in sentiment could lead equities lower, and thus lead the US dollar higher given their negative correlation.

British Pound Weighed Down By Drop in UK CPI, May Be Exacerbated By BOE Meeting Minutes

The British pound traded within a roughly 200 point trading range against the US dollar, remaining under pressure following this morning’s release of UK inflation figures. Indeed, the annual rate of CPI growth fell at its fastest pace since recordkeeping began in 1997 to 4.5 percent in October from a record high of 5.2 percent. Meanwhile, the core measure of CPI, which excludes food and energy, slipped to 1.9 percent from 2.2 percent, suggesting that the Bank of England (BOE) has additional room to cut rates. Wednesday’s release of the BOE’s meeting minutes is likely to reiterate this sentiment, and they tend to be a huge market-mover for the British pound upon release at 4:30 ET. During the November meeting, the BOE’s Monetary Policy Committee unexpectedly slashed the Bank Rate by a whopping 150bps to a 53-year low of 3.00 percent. This came on the tails of the BOE’s participation in the October 8 coordinated rate cuts, during which they reduced the Bank Rate by 50bps. The key to trading this release will be to gauge the vote count, as indications that the decision to cut rates was unanimous could lead the British pound to pull back sharply. The moves may only be exacerbated if the MPC’s discussion sounds dovish or notes deflation risks, as the markets will shift to price in more aggressive rate cuts going forward.

Euro: ECB President Trichet Stresses Difference Between Deflation and Disinflation, Markets Still Bet on Rate Cuts

During a speech in London, European Central Bank President Jean-Claude Trichet said that persistent inflation pressures had dissipated in the Euro-zone and that the ECB hasn’t excluded further interest rate cuts as they intend to avoid deflation. Mr. Trichet subsequently clarified that he saw no signs of deflation, and that was important “not to confuse” it with disinflation. Indeed, the former - a sustained fall in prices where the annual change in CPI turns negative - is something that central banks want to avoid like the plague. On the other hand, disinflation - a decline in the rate of increase in average prices - is to be expected, if not desired, given the plunge in commodity prices since the summer. Continued signs of disinflation should allow the ECB to continue cutting rates in light of the global and regional economic slowdown, which is why Credit Suisse overnight index swaps are still fully pricing in 50bps worth of rate cuts by the ECB at their next meeting on December 4. This factor, along with the solid correlation between EUR/USD and the Dow Jones Industrial Average, continues to work in favor of further declines for the euro going forward.

Japanese Yen Eases Back as Market-Wide Consolidations Continue

The Japanese yen has traded very choppily lately, but remains below its October 24 highs where the low-yielding currency ran into critical resistance versus most of the majors. One of the key trends we’ve been following in the forex markets has been the power of investor sentiment, as bouts of risk aversion have led to sharp gains for the Japanese yen and have triggered major losses for US stock markets. Indeed, the inverse correlation between the Dow and the yen (and US dollar) has been something we’ve been noting frequently. As long as this link holds and volatility stays high, my bias will remain in favor of Japanese yen strength.

Terri Belkas is a Currency Strategist at FXCM.