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FX Market Reaction
By DailyFX – Coming off of an extended holiday weekend, traders in the US capital markets have had sufficient time to prepare for two of… … the biggest events the economic calendar has to offer: tonights Bank of Japan rate decision and tomorrows CPI report.
The inflation data will have a more direct impact on local markets, especially for
the dollar and treasuries. According to the most recent survey, economists expect
the Bureau of Labor Statistics calculations to reveal softer headline inflation
for the month of January while the core indicator stands pat at 2.6 percent. Alone,
these number would not encourage a market reactions either way; but with speculation
and recent Fed chatter factored in, the data could encourage movement. Many market
participants are looking to the inflation numbers (and the FOMC minutes due later in
the day) to clarify the additional dovish rhetoric from Fed Chairman Ben
Bernankes in the short statement offered at the last rate decision and in his
testimony before Congress last week. Should the official communique offer up the
same soft language for inflation and growth projections, expectations of later hikes
and cuts will evaporate. Before the US data hits the wires though, the Bank of
Japans monetary policy group may already have set the tone for the entire
currency market with its rate decision. In fact, the decision may exert greater
pressure on the greenback than the price gauge. In FX circles, the term carry trade
is as well known as trendline. Considering its popularity, the very foundations of
the simple trading strategy could be rocked if the belief that the most prolific
funding currency (the yen) is expected to receive further rate hikes, to cut into
set rate differentials.
Bonds – 10-Year Treasury Note Futures
Treasury traders have clearly changed their outlook for the Feds interest rate
regime in the past month. Since bottoming out at 106-07 back in late January, the
benchmark T-note futures contract has consistent climbed back towards the 108 level.
This turn lines up rather well with the FOMCs policy decision on January 31st,
which produced a notable change of the dovish sort in the official statement.
Looking ahead, the consumer inflation report and FOMC minutes due tomorrow may
extend Treasuries gains should the both reports print as expected the price
gauge softer and the policy comments issuing a stable growth outlook with fewer
warnings assigned to possible price growth. Another event to watch for is the BoJ
decision. Should a pass evolve, US yields will look especially attractive.
FX – EUR/USD
The US dollar has shown some resilience ahead of upcoming domestic and Japanese
economic data, with Greenback bulls successfully defending a falling EURUSD
trendline and Fibonacci retracement. Though recent moves are far from substantial,
the dollars gains against the Japanese Yen through early week trade are
indicative of persistent carry trade interest. Regardless, the upcoming Bank of
Japan interest rate decision and tomorrows US Consumer Price Index numbers may
threaten USD and JPY-linked carry trades. These events provide considerable risk for
an otherwise calm forex trading environment and could prove critical to medium term
price action.
A surprise interest rate hike and a hawkish Bank of Japan could derail price
stability for JPY-denominated pairs and make carry trades significantly less
attractive for risk-averse investors. Though such a scenario is admittedly unlikely,
speculators should be prepared to cover JPY shorts if the Japanese central bank
signals that it is likely to move rates higher through the medium term. In the more
likely case that the BoJ maintains a relatively neutral to dovish monetary policy
bias, the carry trade would likely continue to be a dominant force across currency
markets. This has significant implications for broader US dollar strength, with
tomorrow mornings CPI print to likewise prove significant to Greenback trading.
We should look to short-term price action to provide a clearer outlook for longer
term moves, as the US dollar remains near significant technical levels against the
Euro and Japanese Yen.
Equities – S&P 500 Index
US equities have done little but rally through recent trade, with bullish corporate
profitability news and Fed dovishness contributing to optimism and sending indices
to historic highs. Many wonder how long this may last, but continued 6-year highs on
the broad S&P 500 index have defied calls for impending retracements. The week of
rallies arguably leaves risks to the downside ahead of tomorrows CPI numbers; an
upward surprise in inflation figures could rekindle speculation of US Fed interest
rate hikes. The chart below makes it relatively obvious that few traders fear such a
surprise for the Consumer Price Index, however, and leaves little scope for a rally
on a soft inflation print. Equity traders should subsequently be on the defensive on
any CPI surprises, but any speculative event-linked moves will almost definitely
occur ahead of the 09:30 EDT market open leaving futures traders to dominate any
immediate reactions to the CPI report.
Regards,
John Kicklighter
Forex Capital Markets
32 Old Slip, 10th Fl
New York, NY 10005
Email: jkicklighter@dailyfx.com
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