Dollar Needs Inflation to Sustain Break from Equities, Yields

Talking Points:

• Dollar Needs Inflation to Sustain Break from Equities, Yields
• British Pound Faces Another Wave of Potential Volatility with CPI
• New Zealand Dollar Drops as Inflation Readings Further Cut Rate Forecast

Dollar Needs Inflation to Sustain Break from Equities, Yields

The Dollar opened the new trading week with a mixed performance. Between modest gains against the Euro (0.3 percent) and losses versus the Pound (0.2 percent), the Dow Jones FXCM Dollar Index (ticker = USDollar) closed out Monday virtually unchanged. This is a familiar performance for the greenback. It has struggled to find bearing and momentum throughout August. The lack of performance is remarkable when we put its fundamentals into context. Considering volatility in the FX market and system-wide has cooled materially from the jump experienced just two weeks ago and Treasury yields continue to bleed rate speculation; the assumption would be that the benchmark should be in full retreat. The currency’s endurance likely has a lot to do with the burgeoning trouble experienced by so many of its counterparts – Euro growth, Pound and New Zealand dollar rates, and Yen risk trends. Yet, that relative and indirect performance offers little hope for momentum.

In need of an intrinsic fundamental driver, the dollar is coming into key event risk today. The July consumer inflation (CPI) data is due at 12:30 GMT. While this data could theoretically spur a shift in broader speculative appetites – by leveraging a global response to the implications of global stimulus programs winding down – its more direct impact will come through reshaping Fed rate expectations. US Treasury yields have been in retreat for weeks and implied yield forecasts derived from Fed Funds futures trade at heavy discounts to the FOMC’s own projections. This suggests we are looking at an asymmetrical response opportunity. A ‘weak’ inflation outcome could weigh the dollar; but already bridled with skepticism, the rate impact would be moderated. Alternatively, if the CPI reading beats (headline forecast is 2.0 percent, core 1.9 percent), closing the market’s discount could translate into a rally.

British Pound Faces Another Wave of Potential Volatility with CPI

If the British Pound’s reaction to last week’s Bank of England Quarterly Inflation Report was any indication, the upcoming UK event risk can elicit a serious move from the currency. Ahead, we have a broad range of inflation updates from for the economy. All due at 8:30 GMT, we expect price gauges for the consumer basket (CPI), factory and production levels (PPI), retailer and distribution level (RPI) and the housing market (ONS). When it comes to gauging the time frame of rate hikes for the BoE or any other major central bank, inflation pressures are key. An improved economy and labor situation reduce the need for extraordinary support through stimulus measures, but actually tightening policy typically requires a price motivation. Yet, despite the market’s aggressive rate forecasting, inflation has not taken root. And, this past month, traders have started to adjust for that realization. The market will make a qualitative assessment on all the data, but most focus on the CPI.

Euro Slides as August Economic Surveys Show Further Drop in Growth

Just last week, we were given a troubling update on the Euro-area economy. Second quarter GDP figures showed a general moderation of growth for the region with particular struggles noted in the important ‘core’ members. Yet, some may have found solace in the figures being dated and not indicative of the new ECB stimulus. Well, the economic health survey’s for key Eurozone economies conducted by Bloomberg shows that optimism is short supply. Particular forecast downgrades were noted for Germany and France. Will yields succumb?

New Zealand Dollar Drops as Inflation Readings Further Cut Rate Forecast

Interest rate expectations for the New Zealand dollar have more than cooled – they are collapsing . This morning, swaps are pricing in only 33 bps of rate hikes from the RBNZover the coming 12 months. A month ago, that forecast was 90 bps and six months ago it was 120 bps. The central bank’s hint at the last meeting that it may pause at its next meeting in September triggered a retreat as excess premium bled from the system. But data like this morning’s 2Q PPI unexpectedly dropping 1.0 percent and the two-year CPI forecast easing add fuel to the fire.

Chinese Yuan Hits Five Month High Vs Dollar Despite Troubling Data

The fundamental picture in China is fading quickly, and it’s difficult to say whether authorities can walk that fine line between managing a steady rate of growth while also avoiding a credit bubble implosion. Starting the week off, data from China showed foreign direct investment dropped a massive 17 percent year-over-year through July – the fastest decline in 7 years. Meanwhile, home prices dropped for the most cities in the country in years. Yet, despite this material trouble, the Chinese Renminbi is trading at 6.365 – the highest level versus the dollar since March.

Emerging Markets: ‘Improvement in Ukraine’ Headlines Turn to Russia Data

The lead financial headlines are becoming irksomely familiar. On up days, the reference is to an improved Ukraine situation. On down days, circumstances are said to have worsened. While there is some measure of influence for this geopolitical hotspot, it’s day-to-day impact is likely diminished and requires far more tangible changes to impact the global capital markets. Yet, for Emerging Markets, both broader appetite for risk and the local issues can carry influence. Ahead, Russia is looking at a key round of data on jobs, wages, investment and sales.

Gold Drops Ahead of Key US and UK Inflation Readings

The 0.5 percent decline from gold to start the week does not set off a new trend. For most intents and purposes, the commodity is still trading in congestion – even if SSI and the Commitment of Traders report show an increase in speculative interest. The metal needs a tangible theme to instigate a lasting trend. The upcoming round of US and UK inflation figures can potentially generate interest in its inflation-hedge properties or even as a safe haven. More likely though, a sharp rise or fall in one of these major currencies will provide a direct price swing.

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--- Written by: John Kicklighter, Chief Strategist for DailyFX.com

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