US inflation preview: Determining the dot-plot - 3 scenarios

• The US inflation report is the last significant indicator before Powell's first rate decision.
• Any deviation in Core CPI will cause a drama, and it may be to the downside.
• The Dollar's reaction may be very different against different currencies. 

Will the Fed raise rates three or four times in 2018? We will not have a definite answer until year-end, but the Fed will undoubtedly provide an indication at the upcoming Fed decision. The Fed currently projects three hikes in 2018, but Powell hinted that an upgrade to four rate rises is on the cards and will still be considered gradual. 

But that was before the Non-Farm Payrolls report, which showed a slowdown in wages from 2.9% to 2.6%. Now that doubts have crept in, the inflation report may provide an answer. 

Inflation has been the missing piece in the recent recovery. It has not followed the textbook by rising as the economy reaches full employment. A rise in inflation in January, at least on a monthly basis by 0.3%, has increased expectations that the Fed will have to act faster because inflation is rising in addition to wage inflation. 

This time, monthly Core CPI is expected to be a touch slower: 0.2%. However, the YoY figure is still projected to remain steady at 1.8%. 

This may still be optimistic. One reason is the setback in wage inflation that rose only by 0.1% MoM in February. Core CPI may mirror that and drag the YoY figure lower. Another reason is the weather. Several cold spells during February may have pushed energy prices higher, but otherwise could have distorted sales and weighed on prices.

Also, chances of four rate hikes increased following the Non-Farm Payrolls report despite the unimpressive wage growth. A small disappointment could have a bigger impact than a small upside surprise.

3 scenarios

1) 1.7% or below: A fall in inflation may send the US Dollar down across the board and stocks higher. It will compound the Goldilocks theory of firm growth without inflation and thus fewer rate hikes. The Australian and Canadian dollars could benefit most. Both countries are exempt from Trump's tariffs, and this would extend their recovery. Lower US rates imply stronger emerging market growth and thus more robust growth for these countries. 

2) 1.9% or higher: A surprising increase in core inflation would fully cement an upgrade of the dot-plot to four rate hikes in 2018. The US Dollar would rise, and apart from commodity currencies, the EUR/USD may be a good candidate for a short. The euro is already vulnerable after Draghi's dovishness and fears that euro-zone growth has peaked. 

3) 1.8% as expected: In the "as expected" scenario, the reaction would be to the MoM figure which is forecast to come out at 0.2%. A beat at 0.3% or higher would boost the greenback while a miss at 0.1% or lower would hurt, but the impact would be more moderate. An as expected on this figure as well will move the focus to the headline figures.

In any case, the reaction on the USD/JPY may be more complicated and not necessarily straightforward. The Japanese Yen may attract safe haven flows on robust inflation read, and the yen may lose its shine on a weak inflation reading. However, this behavior is not 100% clear. It may better to stay away from this pair.

Trading the event with the Market Impact tool

Follow the publication of the figure on the economic calendar. Watch out for the data from the Market Impact tool, projecting the potential price changes according to the deviation. Here is the Market Impact Studies Users Guide

Consumer Price Index Ex Food & Energy (YoY)

• Primary currency pair: EUR/USD
• Tradable Positive Trigger: + 1.00 deviation [SELL Pair]
• Tradable Negative Trigger: -1.00 deviation [BUY Pair]
• Key Resistance Level: 1.2390
• Key Support Level: 1.2260

In the last five releases, the EUR/USD moved, on average, 41 pips in the 15 minutes after the release and 66 pips in the 4 hours after the release.

The previous release had a surprise of +1.02 measured regarding deviation, and the EUR/USD reached the 117 pips of volatility 15 minutes after the announcement and 63 in the following four hours.

If it comes out at higher than expected with a deviation of +1.00 or higher, the pair may go down reaching a range of 44 pips in the first 15 minutes and 84 pips in the following 4 hours. If it comes out lower than expected at a deviation of -1.00 or less, the EUR/USD may go up reaching a range of 33 pips in the first 15 minutes and 84 pips in the following 4 hours.

Support levels are to be found approximately at 1.2270 and 1.2245 accordingly to the Confluence Indicator. On the upside, we are watching resistance at 1.2355 and 1.2415.

From a positioning perspective, supply is noted at 1.2390 and 1.2460. Strong vestiges of demand can be seen around 1.2260 and further below at 1.2210, based on aggregated trading positions from FXStreet's dedicated contributors.