Janet Yellen – Rate Hikes After May’s Core CPI?

May 17, 2017
janet yellen

"Let me issue and control a nation's money and I care not who writes the laws." - Mayer Amschel Rothschild (1744-1812), founder of the House of Rothschild

Today, all eyes are on EURUSD as the most traded Forex pair pushes higher like a madman. Euro is gaining ground against the U.S. dollar and the market participants try to figure out what it means. The recent miss in CPI figures is enough for Janet Yellen to tone down the hawkishness or is it the long awaited short squeeze to remove the weaker euro bears?

Unfortunately, I can’t answer that question for you, since I cannot give you a straightforward explanation that would bring 100 percent clarity into the recent price action. Lately, the U.S. data was soft, CPI figures came in lower and the overall growth momentum in the U.S. economy falters. At the same time, it’s no secret that the EURUSD speculative positioning was extremely bearish.

However, the USD bulls have plenty of reasons to be worried. Janet Yellen has emphasized that she runs a data dependent Fed. That same data, that should guide the FED in its monetary policy decisions lacks consistency lately. On top of that, after inflation missed last Friday, the rate hike odds diminished. Will the FED abandon its tightening plans so early?

Read Also: U.S. Inflation: Where to?

Too Early To Throw In The Towel

U.S. dollar lost value on Friday after the CPI figures came. While positive, data disappointed. The overall CPI, year over year, stands above Fed's 2.2 percent. However, the disappointment came from the so-called core CPI (food and energy prices excluded).

The issue is that in the eyes of the market, the core CPI lags momentum. In fact, the year over year core inflation stands at 1.9 percent which marks a new 19 month low. The figure itself is perfectly fine but the investors fear that it won’t be enough for the FED to keep on tightening. On the other hand, both inflation figures hover around the FED’s target area.

The decline in communication fees and the prices of used cars and trucks is to blame for the lower core CPI. Both fell significantly, especially the communication fees as the price of wireless telephone services is moving lower at an elevated pace. In addition, after 17 consecutive monthly increases, the motor vehicle insurance dipped by 0.4 percent.

All in all, with inflation figures still well anchored, one wonders if Janet Yellen and the members of FOMC will hike the rates in June. FOMC meeting schedule is getting tighter as we only have three meetings left in 2017 where we also have a press conference. Right now, what the USD bulls need is time and fortunately, they have some. Keep in mind that the PPI in April increased by 0.5 percent and that will put additional pressure on inflation.

Services Sector Looks Solid

According to the leading indicators, there are reasons to be optimistic regarding the future outlook. The ISM Manufacturing PMI was lower than expected but well above the 50 level. ISM Non-Manufacturing PMI, on the other hand, surged from 55.2 to 57.5. In fact, the services sector PMI hasn’t been below the boom/bust line since the 2nd quarter of 2010. Considering that the U.S. economy is a service based one, the labor market will remain in very good shape.

The March NFP figure surprised negatively. Only 79 000 new jobs, revised from 98K. However, a rebound in April followed. The job creation spiked to 211 000 which should be good news for Janet Yellen. If there is something that supports another increase in the Federal Funds Rate, then it’s the labor market.

Realistically, Fed rate hike prospects may change overnight if the growth pace of the U.S. economy will decrease more. 0.7 percent GDP growth is weak by U.S. standards. Historically speaking, the FED has never raised interest rates under such circumstances. Nevertheless, as long as there is hope that the FED interest rates will rise, the USD bulls will keep on fighting.

Conclusion

Given the recent events and data releases, we reached a point where investors doubt Janet Yellen will hike rates. From now on every piece of U.S. data will have a significant impact on the USD. Recent price action in major pairs reflects market participants' emotions. Dollar selling continues for now.

Capital Properties FX
May 17, 2017

Read Also: Takeaways After BOE Inflation Report

Related Readings
"What Is Monetary Policy? Objectives,Types and Tools"
"Consumer Prices, the Consumer Price Index, and the Cost of Living" - Journal of Economic Perspectives 12(1):3-26 · December 1998 with 197 Reads
DOI: 10.1257/jep.12.1.3

Capital Properties FX