The Week Ahead- Spotlight on Inflation

Dollar and yen ended up mildly high against most majors after a week with FOMC, ECB and BoE meetings. Break of channel support in EUR/USD and EUR/JPY suggested that euro could have topped in both pairs despite ECB’s signal of a June hike and further weakness could be seen. Sterling was also pressured against dollar and yen even though BoE raise rate as widely expected. One exception was the strength in Aussie after unexpected drop in unemployment rate, which is seen in the strong rebound in AUD/USD and break of 100 level in AUD/JPY. Much more volatility is anticipated in the coming week with a jam packed economic calendar. In particular, inflation data and report from US and UK will be in the spotlight.

Fed kept rate unchanged at 5.25% as widely expected. The accompanying statement was essentially unchanged from the previous one on Mar 21. The major change of language was just the acknowledgement of slowed economic growth in the first part of the year, which is in response to recent weak growth data including downside surprise in the Q1 GDP. Housing market’s adjustment is still described as ‘on-going’. And the Fed still expect that economy will ‘expand at a moderate pace over coming quarters. Despite recent reading in tamer core inflation, ” the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected.” After all, Fed still kept options open by saying that “Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”

The statement suggests that Fed members are still adopting a wait-and-see attitude and one month of tamer core inflation data is simply not enough to convince them to shift focus from inflation to growth. This disappointed some dollar bears who speculated the Fed could cut rates as early as June and that’s now priced out after the FOMC meeting. There are still some speculations that Fed will cut rates in 2nd half of the year but believe more ‘accurate’ information will only be obtained from Bernanke after his semi-annual testimony in July.

Data from US were not impressive with trade balance widening more than expected to -63.9b in Mar. Retail sales disappointed the markets by falling -0.2% in Apr with ex-auto sales being flat. This was noticeably much weaker than expectation of a 0.4% rise in both the headline and ex-auto sales. However, Mar’s growth was revised upward from 0.7% to 1.0% while ex-auto sales growth was revised up from 0.8% to 1.1%, Headline PPI rose for the third consecutive months by 0.7% mom, 3.2% yoy in Apr, slightly above expectation of 0.6%, 3.1%. However, core PPI was flat mom for the second month and dragged yoy rate to 1.5% yoy, much weaker than consensus of 0.2% , 1.8%. One bright spot was the surprise drop in jobless claim to 297k, which is was the first time since Jan that jobless claims dropped to below 300k.

ECB did what the market expected by keeping rates unchanged at 3.75% last week with Trichet signaled another rate hike in June by using the coded words “strong vigilance” in the following press conference. However, Trichet offered nothing about the path of monetary policy movements beyond and left the market a divided on how many more hike will ECB make after interest rate reaches 4.00%. Though, two points of interest were noted during the press conference. Firstly, even though liquidity is still ample and is a clear risk to price stability, Trichet cautiously said that overall credit and liquidity conditions are slowly beginning to moderate and M3 are not a precise measure of credit growth. This is taken as an indication that Trichet was trying to downplay recent persistent acceleration in M3 growth. Secondly, when asked about in impact of Euro, in particular with EUR/USD breaching prior high of 1.3668, Trichet avoided the question but repeatedly refer to US Treasury Secretary Paulson’s comment that a strong dollar is in US interests. This is taken as an indication that ECB is mindful of the risks of sharp rise in Euro. But after all, another hike is still anticipated in Sep but there’s still a lot of uncertainty beyond that.

Data from Eurozone saw German Factory orders rising 2.4% mom, 9.9% yoy in Mar. Though industrial production dropped -0.1% mom, dragging yoy rate to 7.7%. Trade surplus widened more than expected to 18.4b but both imports and exports contracted. Wholesale price index rose 0.8% mom, 2.9% yoy in Apr, above expectation of 0.7%, 2.8%.

BoE raised benchmark interest rates again as widely expected after surprisingly high inflation of 3.1% in Mar. However, the 25bps raise was a disappointment to some who expected a 50bps hike. From the accompanying statement, BoE still expects that “CPI inflation is likely to fall back to around the 2% target in the course of this year”. However, BoE notes that with narrowing capacity constraints and enhanced producer pricing power, risk is ’tilted’ to the upside. After all, the tone of the accompanying statement was non-committal, and focus will turn to May 16’s Inflation Report for the latest inflation and output projections for hints on the how much more is needed from BoE to realistically bring inflation down to it’s 2% target. Meeting minutes on May 23 will also be closely watched on the split of votes and views of the MPC members.

Data from UK were not impressive too with industrial production rising 0.3% mom, dropping -0.2% yoy which manufacturing production rose 0.6% mom, 0.9% yoy. Trade deficit widened more than expected to -7.05b in Apr.

Minutes of the Mar BoJ meeting offered nothing new to the markets. The Policy Board noted that it intended to maintain low interest rates for some time and that any adjustments would be gradual and based on the economic and price data. Also, there is no preset schedule for further rate adjustments. However, there were some volatility in yen crosses, in particular with EUR/JPY retreating sharply before rebounding on Friday. Stock market’s movement continued to play a part in yen’s movements as risk aversion and carry trade unwinding theme continued.

Canadian dollar extended recent impressive rally against dollar initially last week after stronger than expected building permits which rebounded strongly by 27.4% in Mar. But the Loonie’s rally was limited after disappointing housing starts. USD/CAD continued to rebound towards the end of the week after Canadian trade surplus missed expectation and narrowed to 4.6b and surprised drop of -5.2k jobs in Apr’s employment report. Meanwhile, the Aussie extended rebound after surprise drop in unemployment rate from 4.5% to 4.4% in Apr but such rebound was limited partly because of pressure in AUD/JPY cross.

The Week Ahead

After a week of central bank meetings, the spotlight is turning to inflation this week. From the US, April CPI will be released on Tuesday and is expected to slow slightly to 0.5% mom, 2.7% yoy from 0.6%, 2.8%. More importantly, with 0.2% mom rise, core CPI is expected to moderate further to 2.4% yoy, which is even closer to Fed’s comfort zone of 2-3%. Note that after re-accelerating to 2.7% in Jan and Feb, core CPI moderated to 2.5% in Mar which was then the lowest since May 06’s 2.4%. However, one month of data was not enough to ease Fed member’s mind as inflation remains their predominant concern. However, such situation will probably change if core inflation continues to moderate as markets expected.

Another focus will be on Thu’s jobless claims which is expected to rise back from 297k to 310k. However, in case of downside surprise, another week of below 300k data will likely give dollar a boost on prospects of a rebound in NFP in May. Other data from US include TIC capital flow, regional Fed survey from NY State and Philadelphia, housing starts and building permits, industrial production and capacity utilization.

From Eurozone Apr CPI and HICP final from Germany and Eurozone will be featured. However, more focus will actually be on Tue’s Q1 GDP flash which is expected to slow slightly from 0.9% qoq, 3.3% yoy to 0.5% qoq, 2.9% yoy. Though, this is still very solid and supportive to further rate hike from ECB down the road.

Inflation will definitely be the focus in UK this week with PPI data featured on Mon and CPI data featured on Tuesday. In particular, CPI is expected to retreat mildly from 3.1% yoy to 2.8% yoy and such data could ease some concerns of the MPC members. After that, on Wed, BoE’s much anticipated Inflation Report will be released where updated inflation forecasts after Mar’s surprisingly high data will be provided. This will be the most important piece of inflation to shape expectation for how many rate hikes is needed for BoE to bring inflation down to its 2% target.

BoJ is expected to leave rate unchanged at 0.5% this week and so that would likely be a non-event. Focus will be more on Q1 GDP data which is expected to slow from Q4’s exceptionally strong growth of 1.3% qoq, 5.5% annualized rate to 0.7% qoq, 2.7% annualized. For the commodity currencies, focus will mainly be on New Zealand retail sales and Canadian CPI.


EUR/USD fall from 1.3681 extended further to as low as 1.3461 last week. Short term rising channel support was taken out by such fall and there was also sustained trading below 4 hours 55 EMA. This warns that the rise from 1.2865 could have completed at 1.3681 already, with bearish divergence conditions in 4 hours MACD and RSI. Short term outlook is turned bearish. Even though further recovery could be seen initially this week towards 4 hours 55 EMA (now at 1.3554), upside is expected to be limited below 1.3627 resistance and bring further fall towards 1.3406/10 support zone (with 55 days EMA at 1.3417 now). Sustained break of this support zone will confirm that rise from 1.2865 has completed and deeper decline should then be seen towards 1.3253/58 support. However, break of 1.3627 resistance will indicate that the fall from 1.3681 is merely a correction and has completed. In such case, rise from 1.2865 is still in progress for above 1.3681 high.

In the bigger picture, with 1.3668 target met, risk of medium term reversal is also increasing. As discussed before, medium term up trend from 1.1639 is interpreted as having first move completed with three waves up to 1.2978, subsequent sideway consolidation completed at 1.2483. Rise from 1.2483 is treated as resumption of the whole up trend from 1.1639. With such interpretation we’d expect risk of medium term reversal to increase significantly as EUR/USD enter into resistance zone between 1.3668 and 100% projection of 1.1639 to 1.2978 from 1.2483 at 1.3822. Hence, focus is now on reversal signals.

On the downside, break of the short term rising channel support is already a warning that the rise from 1.2865 has completed. Decisive break of 1.3406/10 support, with 55 days EMA (now at 1.3413) taken out too, will confirm such case. More importantly, with bearish divergence condition in daily MACD and RSI, this will be the first warning that the whole rally from 1.2483 has also completed, and, so is the whole up trend from 1.1639. Focus will then be back to medium term rising channel support (now at 1.3011).

In the longer term picture, it’s still early to conclude whether medium term rally from 1.1639 represents resumption of multi-year up trend from 0.8223 or just part of a large scale consolidation that started at 1.3668. But, the three wave corrective nature of the rise from 1.1639 to 1.2978 suggest that this whole rally from 1.1639 will be corrective in nature, thus, favoring the latter case. And therefore, as discussed above, focus will be on reversal signal when EUR/USD enter into resistance zone of 1.3668 (04 high) and 100% projection of 1.1639 to 1.2978 from 1.2483 at 1.3822. But sustained break of this resistance zone will path the way towards 95 high of 1.4523.

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