CPI numbers could shake the Dollar up

• February 22, 2006
• Kathy Lien

US Dollar

The performance of the US dollar has been mostly mixed against the majors.  The
Euro gave back some of last week’s gains as trading continues to remain very
quiet.  The dollar gained strength after the surprisingly sharp rise in leading
indicators for the month of January.  Expected to only increase by 0.6 percent,
leading indicators jumped 1.1 percent with an additional upward revision for the
data released the previous month. 

Last week’s list of stronger economic data including retail
sales, manufacturing sector surveys and a low jobless claims report continue to
support the case for solid first quarter GDP growth and possibly even a nice
revision to the weak number that we saw last month.  However, the dollar rally
was limited as the FOMC minutes created an air of uncertainty.  Even though the
Federal Reserve was optimistic on growth and confirmed that “some further policy
firming may be needed,” outgoing Fed Chairman Greenspan did take this
opportunity to warn that the housing market poses a risk to demand and that
monetary policy “seemed close to where it needed to be” and as a result, “rate
moves can’t be prejudged with past confidence.”  This slight tinge of
neutral-ness threatens expectations for a May rate hike, but given that these
opinions reflect the FOMC under Greenspan and not Bernanke, the market is not
entirely convinced that the March rate hike will be the Federal Reserve’s last. 

Thankfully today’s consumer price inflation report has the
potential to stir up the markets a bit.  After the sharp rise in producer prices
reported last week, the market is now anticipating a nice jump in CPI.  If the
report fails to meet expectations for higher inflation, the dollar could
continue to give back some of its gains.  On the other hand, if headline
consumer price inflation grows by more than 0.5 percent and core inflation grows
by more than 0.2 percent, then we may finally see the dollar resume its rally.

Euro

Despite another dose of mostly better economic data, the Euro failed to register
any gains against the dollar. The Eurozone reported a narrower trade deficit of
-EUR 900 million compared to the market’s forecast of —EUR 1.9 billion for the
month of December.  The deficit for the month of November was also revised
lower.  Meanwhile France also grew by 0.2 percent in the fourth quarter, which
was right in line with expectations, but consumer prices fell by a less than
expected 0.1 percent last month. 

ECB officials continued to call for a rate hike in March with
both Garganas and Wellink chiming in today.  Wellink’s comment was probably the
clearest, as he said that “monetary policy should be proactive” in the current
environment of “ample liquidity, low interest rates and persistently high oil
prices.”  Yet even though we know with near certainty that the European Central
Bank plans to raise interest rates in March, the Federal Reserve is also
expected to do the same and then possibly tighten again in May.  Therefore at
this point it seems unlikely that for the ECB’s interest rate hikes to give much
momentum to the Euro unless the Fed stops raising rates, leaving the ECB as the
only hawkish central bank of the two.  This shift in dynamic is probably not
expected until the second half of this year.

British Pound

For the third consecutive trading day, the British pound strengthened against
the dollar and completely decoupled from trading in tandem with the EUR/USD. 
Mergers and acquisition flows are helping to keep the pound bolstered, but most
of the careful upward momentum has stemmed from expectations that the Bank of
England minutes due for release tomorrow could be a bit more neutral than the
previous release. 

Economic data has been very mixed, but as we mentioned
yesterday, although the BoE voted to keep interest rates unchanged for yet
another month, the balance of the votes could very well shift this time around. 
At the last meeting that the minutes were published for, BoE member Steve
Nickell was the only voter to favor an interest rate cut.  For this meeting,
forecasts are very divided with some analysts calling for more members to vote
in favor of a rate cut while others predict that Nickell could have voted to
leave rates unchanged at the time, which would shift the vote for no change from
8-1 to 9-0.

Japanese Yen

Once again the dollar continued to rally against the Japanese Yen despite a 450
point rise in the Nikkei overnight.  After two days of back to back losses, last
night’s rebound was certainly encouraging.  Convenience store sales were the
only economic data released last night and for the 18th month in a row, store
sales printed negative.  With no end in sight for the tug of war between the
Bank of Japan and the Japanese government, there seems to be little that can
help the Yen in the immediate future other than a breakdown in the US dollar
component of the pair.  Of course, an end to quantitative easing or rumors of an
economic outlook upgrade by the Japanese government could help the Yen a tad,
but probably not enough to cause a complete reversal in trend.  Improving
economic data is something that we have been seeing for weeks and the Yen has
reacted little. 

Kathy Lien

Kathy Lien is the Chief Currency
Strategist at
Forex Capital Markets.
Kathy is responsible for providing research and analysis for

DailyFX,
including technical and fundamental research reports, market commentaries and
trading strategies. A seasoned FX analyst and trader, prior to joining FXCM,
Kathy was an Associate at JPMorgan Chase where she worked in Cross Markets and
Foreign Exchange Trading.

Kathy has vast experience within the interbank
market using both technical and fundamental analysis to trade FX spot and
options. She also has experience trading a number of products outside of FX,
including interest rate derivatives, bonds, equities, and futures. She has a
Bachelors degree in Finance from New York University. Kathy has written for
Stocks and Commodities, CBS Market Watch, ActiveTrader, Futures and SFO
Magazine. She is frequently quoted on Bloomberg and Reuters and has taught
seminars across the country. She has also hosted trader chats on EliteTrader,
eSignal, and FXStreet, sharing her expertise in both technical and fundamental
analysis.