Euro Looks to CPI for Guidance, US Dollar May Fall on FOMC Minutes

Talking Points:

• Euro May Bounce if December Inflation Data Proves Better Than Forecast
• US Dollar Vulnerable if FOMC Minutes Undermine Hawkish Fed Outlook
• Japanese Yen Corrected Lower Overnight After 2 Days of Aggressive Gains

December’s preliminary Eurozone CPI data is in focus in European trading hours. The benchmark year-on-year inflation rate is expected to drop into deflationary territory for the first time since November 2009, reflecting a 0.1 percent decline. While the trajectory of price growth readings has undeniably pointed lower for some time, realized outcomes relative to expectations have actually improved over recent months. That suggests analysts may be overestimating the severity of the slide into deflationary territory, opening the door for an upside surprise. Such a result may cool ECB stimulus expansion bets, boosting the Euro as prices test pivotal chart support.

Later in the day, the US Dollar may face selling pressure if minutes from December’s FOMC policy meeting force investors to rethink the announcement’s hawkish implications. The greenback rallied when the results of the sit-down were unveiled, seemingly inspired by the Fed’s decision to back away from language pledging to keep rates low for a “considerable time following the end of its [QE3] asset purchase program”. Instead, policymakers adopted new verbiage arguing that the central bank can be “patient in beginning to normalize the stance of monetary policy”. The currency’s reaction suggests this was seen as a hawkish guidance shift.

Traders may have over-estimated the implications of the Fed’s language adjustment however. The pre-December narrative was conditioned on the end of QE as a reference point. With that program over, an update was probably appropriate on purely contextual grounds and need not have signaled a policy change. Indeed, Fed Chair Yellen and company explicitly said that the new guidance is “consistent” with the old. Meanwhile, the FOMC trimmed the expected scope of rate hikes in 2015. The average in December envisioned the outer band of the baseline rate range at 1.25 percent by the end of next year compared with 1.4 percent in September’s outlook.

The Japanese Yen underperformed in overnight trade, falling as much as 0.6 percent on average against its leading counterparts. The move appeared corrective after the currency put in the strongest advance in three weeks on the back of risk aversion to start the trading week. An aggressive selloff on global stock exchanges has translated into an unwinding of carry trades funded in the perennially low-yielding currency, fueling short-covering on anti-JPY bets.

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--- Written by Ilya Spivak, Currency Strategist for DailyFX.com

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