US Dollar May See Biggest US CPI Drop Since 1950 on Wednesday

The US dollar ended on a mixed note on Tuesday, losing out against the euro, Swiss franc, British pound, and Japanese yen while gaining versus the commodity dollars. While the currency did stage a solid rally during the US trading session, it ultimately wasn’t enough to make up for the greenback’s heavy losses experienced during the European trading session. US economic news was broadly mixed, as the Labor Department said that US producer prices rose by 0.2 percent in May, but this monthly gain did not prevent the annual rate from falling further to a nearly 60-year low of -5.0 percent. The drop in the annual rate suggests that Wednesday's US CPI release could be similarly weak on an annual basis. Adding to the mix, the Commerce Department reported that housing starts jumped for the first time in three months by 17.2 percent in May to an annual rate of 532K from a record low of 454K. Likewise, building permits rose by 4.0 percent during the month to an annual rate of 518K from a record low of 498K. Manufacturing sector data was not as optimistic, though, as the Federal Reserve's industrial production index fell more than expected at a rate of -1.1 percent, marking the seventh straight month of contraction. Indeed, as we've noted in the past, the persistent slowdown in both domestic and foreign demand has taken a hefty toll on the manufacturing sector, which has shown no signs of recovering.

The latest inflation figures for the US are forecasted to show slight increases on a monthly basis, but clear weakness on an annual basis. Indeed, headline CPI is projected to have risen 0.3 percent during May, while the core measure, which excludes food and energy, is anticipated to rise 0.1 percent. Meanwhile, headline CPI is expected to have fallen 0.9 percent in May from a year ago, the steepest drop since February 1950, compared to a decline of 0.7 percent in April. On the other hand, core CPI may have only eased to a 1.8 percent annual pace of growth from 1.9 percent, suggesting that volatile commodity prices are the sole reason for the contractions in headline inflation. Weaker than expected results have the potential to stoke deflation fears, but overall, the FX markets haven’t shown a strong reaction to past CPI reports, and this time around we may see more of the same.

British Pound Makes Headway as UK CPI Remains Above BOE’s Inflation Target

The British pound was among the strongest currencies of the day, and rallied after the Office for National Statistics reported that the UK consumer price index (CPI) jumped 0.6 percent during May, due primarily to increases in food, alcohol, tobacco, household, and transport costs. The rise in prices was more severe than anticipated, and kept the annual rate of CPI growth aloft at 2.2 percent, down from 2.3 percent. This ultimately leaves inflation above the Bank of England's 2 percent target, and suggests that they will not feel the need to aggressively expand their quantitative easing program, which is why the British pound shot higher upon this release.

Looking ahead to Wednesday, the release of the minutes from the Bank of England's June 4 meeting may not be as market-moving as they've been in the past, as there has already been significant detail revealed about the mindset of the Monetary Policy Committee (MPC). Indeed, we already know that the BOE has decided to expand their quantitative easing (QE) program by 50 billion pounds to 125 billion pounds, but there are indications that they may increase the scope of the program even further as they recently published a paper in which they sought comments on the prospect of including purchases of secured commercial paper in their Asset Purchase Facility (APF). That said, the inclusion of secured commercial paper doesn’t necessarily mean that they will allocate more money toward the APF, and this is a detail that will be critical to British pound price action as past QE announcements have weighed on the currency. At the same time as this release, UK jobless claims will hit the wires and they are projected to rise for the fifteenth straight month in May, this time by 60,000, while the claimant count rate may rise to 4.9 percent, the highest since October 1997, from 4.7 percent.

Japanese Yen Rallies Over 1% as US Equities Tumble for Second Day

The Japanese yen ended Tuesday as the strongest of the majors once again, but experienced some seriously choppy price action as the currency actually fell very sharply during the European trading session. However, risk aversion reared its head once again during the US trading session, taking the DJIA down 1.3 percent to end the day just above the psychologically important 8500 mark. Meanwhile, the latest commentary from the Bank of Japan (BOJ) was optimistic, but didn’t have much of a direct impact on price action. As expected, the BOJ left rates unchanged at 0.10 percent, but they also upgraded their outlook for the second straight month, saying that “economic conditions...have begun to stop worsening.” That said, the BOJ also noted that downside risks remain for the economy and for inflation, which are contingent upon “future developments in the global financial and economic situation.” Ultimately, the Japanese yen remains a crucial component of the FX carry trade, and the currency’s moves are likely to remain tied to market-wide risk trends rather than fundamental forces.

Euro Mixed as Euro-zone Inflation Data Reflects Stagnation in Price Growth

The euro lagged against the British pound and Japanese yen on Tuesday after Eurostat confirmed their initial estimates showing that that the annual rate of CPI growth stagnated during May as energy prices remain down sharply from a year ago. Meanwhile, core CPI (which excludes volatile food and energy costs) slipped to an annual rate of 1.5 percent from 1.8 percent. All told, it is fairly clear that any downward price pressures in the Euro-zone are primarily the result of weaker commodity prices. The data isn’t likely to cause too much concern amongst European Central Bank officials, though, as they have already stated that they anticipate that CPI growth will “decline further and temporarily remain negative over the coming months, before returning to positive territory by the end of 2009.”

Terri Belkas is a Currency Strategist at FXCM.