CPI Shapes Tapering Pace

A broad decline in the US dollar following a US inflation print that matched consensus highlights market uncertainty around the path of Fed rates. Comments from Evans and Barkin also underscore the rift at the FOMC. The 83 double barrier in USDX coincided with 1.17 support in EURUSD. 

US CPI rose 5.4% y/y compared to 5.3% expected on Wednesday, but clearly Mr Market wasn't expecting the same thing as economists. Rather, it was fearful of a higher print that would tip the FOMC towards tapering in September at a quicker pace. Fed tapering is no longer a question of when, but how much. Thus, the Fed could well start reducing asset purchases in Oct or Nov but at a more modest pace than expected. 

Instead, the CPI report showed plenty of reasons to believe that prices are cresting. Core CPI was in line at 4.3% y/y and a four-month low of +0.3% m/m.. Gasoline contributed a 41.8% y/y rise but oil prices have steadied in the past two months. If crude stays near $70, that contribution will be 0% in less than a year. Used auto prices have been a talking point in this report and rose 0.2% m/m after three months of at least 7.3% m/m rises. Those will eventually put negative pressure on the headline.

The inflation numbers came shortly after two Fed centrists – Evans and Barkin – pushed back against an earlier taper. Both said they wanted to see a few more months of jobs data. Markets had recently been considering a quicker taper starting in September, but Nov/Dec taper at a slower pace is more likely.

With that, the dollar fell sharply on the report, sinking as much as 50 pips initially. That price action highlights just how tuned-in the market is to inflation and the FOMC. This is undoubtedly a fundamentally-driven market at the moment as these numbers an non-farm payrolls prove.