Fed policy uncertainty increased three folds after the CPI miss.
Just as the dollar was picking up some momentum, it got hammered back to reality as the doggedly unexceptional CPI prints continues to haunt the dollar bulls.
When it comes to gauging inflation, it could be time to throw the textbook theory out the window as despite unemployment falling there’s little sign of inflationary pressures flaring up. Also, the Fed’s preferred inflation measure, the core PCE index, has consistently fallen short of its target rate of 2 percent, so its either time to update the old Phillips Curve or finally conclude that the influence of technology on lower prices will likely persist for the foreseeable future.
Either way, the monthly rituals surrounding these inflation prints are adding more confusion rather than clarity regarding monetary policy. Perhaps we’ve become too accustomed to knowing that when it comes to inflation, the Feds are the only game in town.But I’m sure if you asked most traders why the Feds have set a 2 % inflation target, besides a lot of blank stares, the likely response would be " it is because it is".
The clear example of how confusion within the Fed inflation mandates distorts dollar conviction sentiments can analyse market behaviour. After last weeks boisterous average hourly earnings print USD conviction soared to +2.5 on a scale +/- 3 but then dropped to -1.5 post CPI. These position Flip Flops add an unwanted element of disorder that could be quickly ironed out by a decisive Fed
The week ahead could be pivotal on numerous levels
The British Pound
The Brexit drama should escalate, as May is expected to touch on the topic of a transition deal at the EU leaders’ summit. But from the EU perspective, this is likely to be a case of " show me the money "and EU leader will continue to baulk at any proposal until a divorce check is signed. This scenario does not portend well for the Pound next week
The Euro
The Spanish Referendum is now inconsequential to currency markets, But the Australian election on Sunday could provide some fodder especially if the far-right Austrian Freedom party has a stronger showing than expected. The right-wing Freedom party is expected to form a coalition partnership, but a stronger appearance could ruffle a few EU leaders feathers. By all accounts, range trade mentality should remain the order of the day.
Tax Reform
Tax reform passage will struggle given the fragile GOP majority as the lack of support from both McCain and Corker’s could be the ultimate nail in the coffin. But given Trump’s current approval ratings, unless the Republicans can move this reform through the Senate quickly, there’s no guarantee they will have a sitting majority after the midterm election.
The Ultimate Game of Thrones
Without a doubt, traders went into the US CPI and retail sales data with one thing on their mind, who is the next Fed Chair.
One of the exciting candidates that are churning the rumour mill is Stanford Economist John Taylor who is the most hawkish among the perceived frontrunners.
Much of the initial market debate centred around the "Taylor Rule" an interest rate forecasting model invented and perfected by Dr Taylor which estimates Fed Funds~3.75% vs 1.25 % presently. The market was a bit shell-shocked initially until a flurry of Google searches discovered that his recent on the record comments better align his views with the current Feds gradual pace of normalisation. None the less he does present a more hawkish alternative to the current front-runner Powell and Warsh who currently sit atop the bookie boards at 45% and 25% respectively
Regional sentiment:
New Zealand Dollar
The New Zealand election upheaval should be settled Monday when the NZ First board will meet to decide whether to support either Labour or National in government. Once again politically driven mean reversion trades prove to be a significant risk-reward, even more so when the USD has failed to gain any real traction over the last six weeks.
China
Let not lose sight of the 19th Communist Party Congress kicks off in China which is expected to produce a deluge of headline risk. Last week the RMB complex was arguably one of the primary drivers in regional USD dollar sentiment so local traders will have eyes focused and ears to the ground on headline risk.
Last but not least we have the China data dump to deal with throughout the week as CPI, GDP, retail sales and industrial production will provide some good food for thought.
Australian Dollar
Other then Fed speak, and unlikely hawkish shift at the Fed Helm USD should continue to suffer at the expense of high beta FX. The Aussie dollar finished the week on a positive tone and appeared poised to extend gains next week.
