Muted US Inflation Derails Dollar Recovery

Global Political Uncertainty in Driving Seat

The US dollar is trading lower on Friday after the consumer price index (CPI) and the preferred inflation metric the core CPI came slightly under expectations. Fed speakers had been divided in their comments leading up to the release. Doves thought it was a mistake to keep raising rates with low inflation. Hawks urged that waiting could be a bigger mistake and that inflation will eventually catch up. The disappointing data has not taken the December rate hike off the table, with the data between now and the date of the meeting to provide the final say.

The CME FedWatch tool is showing a decrease in the probabilities for a December US interest rate hike. The calculation is done using the prices of Fed funds target rates futures and it stands at 82.9 percent. One week ago it was 87.8 percent, but also worth mentioning a month ago the odds were below 50 percent for a lift at the end of the year.

The USD regained some of the ground lost after the CPI release with the comments from US President Trump that refused to certify the Iran nuclear deal but has not officially terminated the deal and solutions can still be achieved. Political uncertainty remains a critical factor as the US faces an uphill battle in the fourth quarter and alongside Brexit the European Union has to deal with the situation in Catalonia.

The EUR/USD lost 0.07 percent on Friday and will post a 0.75 percent weekly gain. The single currency advanced versus the dollar after the US consumer price index (CPI) disappointed and will put pressure on the U.S. Federal Reserve as the December Federal Open Market Committee (FOMC) still has a rate hike priced in by the market. Statements from US President Donald Trump about Iran’s nuclear deal that could involve new sanctions changed the direction of the pair on Friday.

Earlier at the end of the week the European Central Bank (ECB) president had said that the European Union continues to enjoy a firm and broad based economic expansion. European data this week supported that view as industrial production jumped 1.4 percent in the region. Germany and Italy surprised by beating estimates. German inflation remains low at 0.1 percent as for all the work of the ECB the pull of deflation is too hard to shake off.

Final CPI for the European Union will be released on Tuesday, October 17 at 5:00. Inflation is expected to have remained steady at 1.5 percent. An improvement over that will be seen as a positive by the market specially after the US data underperformed on Friday.

The GBP/USD rose 0.21 percent on Friday. Cable has been reacting to different Brexit scenarios. Rumours of a softer breakup after both sides admitted being at a deadlock saw the pound rise. The currency rose 1.72 percent on a weekly basis as the chief negotiator for the EU Michael Barnier confirmed that he will not recommend the talks move to the next phase until the deadlock is resolved. A harder Brexit was implied but rumours about a way to transition the UK out of the EU with members discussing several options on October 19–20.

The biggest issue that is keeping negotiations from moving forward are the UK’s financial obligations to the EU. While the conservative party has said that no deal is better than a bad deal the market disagrees with that assessment as exiting the EU without a deal would mean higher levels of uncertainty making asset valuations harder.

The dollar was falling on Friday after a lukewarm CPI data release. The U.S. Federal Reserve has been supportive of the USD with two rate hikes, but low inflation has always made it questionable if there will be a third one.

Market events to watch this week:

Monday, October 16
5:45pm NZD CPI q/q
8:30pm AUD Monetary Policy Meeting Minutes
Tuesday, October 17
Tentative GBP BOE Gov Carney Speaks
4:30am GBP CPI y/y
Wednesday, October 18
4:30am GBP Average Earnings Index 3m/y
8:30am USD Building Permits
10:30am USD Crude Oil Inventories
8:30pm AUD Employment Change
10:00pm CNY GDP q/y
10:00pm CNY Industrial Production y/y
Thursday, October 19
4:30am GBP Retail Sales m/m
8:30am USD Unemployment Claims
Friday, October 20
8:30am CAD CPI m/m
8:30am CAD Core Retail Sales m/m
7:15pm USD Fed Chair Yellen Speaks

*All times EDT
For a complete list of scheduled events in the forex market visit the MarketPulse Economic Calendar

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Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency
trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza