US CPI to throw light on inflation as reflation trade persists – Forex News Preview

US CPI to throw light on inflation as reflation trade persists – Forex News Preview

Posted on March 9, 2021 at 4:44 pm GMTChristina Parthenidou, XM Investment Research Desk

US CPI figures for February will be front and center on Wednesday at 13:30 GMT amid fears the cocktail of massive monetary and fiscal stimulus and the reopening process from the lockdown could stoke inflation. The data are expected to endorse that narrative, likely adding more support under the dollar as the elevated Treasury yields indicate that Powell’s calm tone last week was not very convincing for investors.

Powell’s reassurances at odds with inflation expectations

Last week, and a few days before the blackout period starts, Federal Reserve chair Jerome Powell underlined that inflation may pick up steam in the coming months, but any upside pressure will likely be transitory and insufficient to alter the current ultra-loose monetary policy of stable bond purchases and record low interest rates for the next two years.

Despite his reassurances, the US 10-year Treasury yield eased only slightly to continue its aggressive rally to a fresh one-year high on Friday after the closely watched US nonfarm payrolls popped notably above forecasts. The yield reaction, and the fact that inflation expectations keep pointing upwards, stresses that investors remain stubbornly concerned that a fruitful economic recovery could come with the cost of high inflation. And perhaps Biden’s $1.9 trillion fiscal pandemic package approved by the Senate over the weekend could only add more fuel to prices, leading to an earlier stimulus tightening.

An inflation upturn could be a temporary phenomenon

The truth is that a spike in inflation measures could indeed be on the way due to temporary technical reasons. The low base effect from the abnormally low levels of inflation, particularly during the spring period of 2020, could boost price gauges sharply to the upside. The rebound in oil prices and the expensive price of raw materials, which emerged from supply chain bottlenecks, could also be another tailwind as the sharp upturn in the business ISM price index revealed a few weeks ago.

Hence, given the above, stronger CPI inflation figures on Wednesday should not drop a bombshell, though given that the first round of lockdowns took effect in the second quarter of 2020, and therefore prices in the US were pretty much unaffected from the pandemic last February, investors may closely inspect whether any earlier spike in inflation could be something more than a one-off distortion from the Covid crisis. Specifically, the headline CPI is expected to climb to 1.7% y/y from 1.4% in January and tick from 0.3% to 0.4% compared to the previous month. The core measure, which excludes food and energy, is said to hold steady at 1.4% y/y, suggesting that volatile items have been the main growth drivers so far.

Higher inflation could provide more bullish fuel to the dollar

As regards the market reaction, although an upshot in inflation seems to be largely priced in the coming months, what is still unknown is whether a potential acceleration could be sustainable at a time when the unemployment rate remains well above pre-pandemic levels. Perhaps a confirmation may come in the third quarter, though with investors being sensitive to inflation news, a significant upside surprise in CPI data could bring monetary tightening jitters back into play in the near term, likely further raising buying confidence in the dollar. Such an outcome could see dollar/yen flying back into the 109.00 area, with resistance expected to emerge near June’s peak of 109.84.

Alternatively, if the numbers miss forecasts, justifying Powell’s calm stance, dollar/yen could give up some ground to test support at 108.30. Breaking below 108.00, the surface of the bullish channel seen around the 107.50 region may attempt to add some footing.

On Friday, US PPI data for February could provide more clues on inflation at 13:30 GMT.

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