Had it not been for the Federal Open Market Committee’s (FOMC) reminder to watch overall inflation, the U.S. dollar would have sustained more damage today because of today’s core PCE price index reading of 1.9%, which is below the higher end of the Fed’s comfort level.
We cautioned in our post-FOMC commentary yesterday, “This new phrase focusing on headline inflation is a function of the Fed’s emphasis on … higher …overall price pressures. We also deem it as a tactical move by the central bank to temper any excessive market optimism ahead of tomorrow’s core PCE price index, which could come in below 2.0%.”
Indeed, the core figure came in at three-year low of 1.9%. But with the headline rate pushing back to 2.3%, bond and equity bulls will have to temper their excitement about any notion of cooling inflation thanks to yesterday’s reminder by the FOMC on headline inflation.
Nonetheless, a prolonged divergence between headline and core U.S. inflation may not only prove negative for the U.S. dollar but will resurrect tendencies of stagflation fears, thus highlighting the Fed's policy dilemma. This is especially the case as housing and rising energy prices weigh on consumer spending.
Put differently, renewed downside risks are expected to slacken the utilization of resources and further weigh on core inflation.
Although both personal spending and income came in weaker than expected (0.5% vs. 0.7% and 0.4% vs. 0.5%), the figures paint a reassuring second quarter picture for the all-important U.S. consumer, especially as incomes are keeping up with spending. But the risk trifecta of prolonged energy prices, falling home prices/rising mortgage costs and stock market losses bear dangers ahead into second quarter and third quarter.
With core U.S. inflation clearly down and headline inflation remaining elevated, the Fed will continue to remind markets of the latter. This should maintain the ongoing normalization of the U.S. yield curve to the point of weighing on capital and consumer spending. 10-year yield are currently trading at 5.03%, facing considerable resistance at 5.15%, a break of which is seen calling up the further gains and risks ahead.
Canada’s April GDP came in flat, disappointing expectations of a 0.3% following 0.3% in March. This is prompting USD/CAD to regain some of its losses, targeting our projected resistance of 1.0620, which may be breached for the more durable resistance of 1.0630—61.8% retracement of the 1.00730-1.0466 plunge. Rising oil prices may continue to prop CAD against the euro and Aussie.
The high yielding Kiwi surged to a fresh 25-year high of 0.7736 after New Zealand's first quarter GDP rose 1.0% from 0.8% in Q4. At first, the report generated a neutral reaction in the Kiwi on expectations that the data may not sufficiently indicate overheating to prompt the Reserve Bank of New Zealand into higher interest rates. But the currency jumped pushed higher against the USD later in the European session amid a broad selling in the U.S. currency.
Ashraf Laidi Chief FX Analyst CMC Markets US 140 Broadway, 30th Floor New York, NY 10005
(212) 644-4220
a.laidi@cmcmarkets.com
