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Former Federal Reserve Chief Alan Greenspan had many unique viewpoints on a variety of economic subjects. Love his suggested policies or hate them, one thing is for certain, he had a profound impact on the American economy. Tomorrow at 7:30 a.m. EST, Greenspan’s favorite inflation gauge will be released.
It’s called the Personal Consumption Expenditure Deflator or simply the PCE Deflator. I agree it’s a strange name for an economic indicator, sounding more like an industrial tool or device to deflate inner tubes on the beach. Greenspan strongly believed that this indicator is the most accurate gauge of inflation available. It’s watched closely by Forex traders as it can have dramatic impact on dollar based pairs such as the EUR/USD. Let’s take a closer look at the PCE Deflator.
It’s similar to the Consumer Price Index in some ways; however, instead of calculating based on a fixed basket of goods, it is based on the average price increase for all personal consumption. A chain or “deflator” of price increases, if you will. It accounts for consumers switching from one product to another due to price increases, thereby it is considered to be a more accurate and dynamic inflation measure than the CPI.
The release on Friday is expected to come in at 4.4, up from the previous figure of 4.1. Any increase or decrease from that expected number will throw the EUR/USD pair, potentially severely. If the number is greater than expected, this means that inflation is in full effect, which will exert influence on the Federal Reserve to raise interest rates. This, in turn, will strengthen the dollar causing the EUR/USD pair to drop.
If you believe that inflation is on the rise, short the EUR/USD pair prior to the release. On the other hand, if the PCE Inflator comes in lower than the expected 4.4, expect the dollar to weaken, thus sending the EUR/USD to pair higher. If this is your opinion, going long on the EUR/USD is how to reflect it. Other traders may want to wait until after the release and then fade the move, if it’s sharp, after the momentum has slowed down. This move retrace style trading is very popular in the FX world.
Regardless of your opinion or style, one thing is a constant, ALWAYS position size properly as the FX market can be unforgiving.
Best Wishes!
David Goodboy is Vice President of Marketing for a New York City based multi-strategy fund.
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