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US interest rates in balance as traders await CPI data

Carl Capolingua Carl Capolingua 10/05/2023
US interest rates in balance as traders await CPI data US interest rates in balance as traders await CPI data
US interest rates in balance as traders await CPI data Carl Capolingua

Download Carl's Bear Market Survival Guide e-Book:
https://www.thinkmarkets.com/au/lp/2023-bear-market-survival-guide-ebook/


One of the most important economic data releases on the monthly calendar is the Consumer Price Index (CPI).

The CPI measures the price change of a basket of commonly consumed goods and services in the US economy. If the basket of goods and services is increasing in price it is referred to as "inflation". Aha I hear you say! The dreaded 'I' word! 

It doesn't happen very often, but if the basket of goods and services is decreasing in price it is referred to as "deflation". Given in the current environment the price of pretty much everything we buy feels like it's going up, it's difficult to even contemplate deflation. But it's not as uncommon as you might think. We last saw three consecutive negative CPI prints back in June 2020 after the COVID-19 pandemic broke.

Fast forward to today, and ironically, the fallout of the same pandemic is causing an extended period of inflation. It peaked at just over 9% p.a. in July last year and had cooled to 5% p.a. as of last month's reading of the March CPI. It does on first pass appear inflation has moderated significantly. 

A couple of points here. Firstly, in the period since last July, the decline in the rate of inflation is not deflation. Yes, annualised inflation is coming down, but it's still positive. Prices are still rising. Rather, we refer to periods such as these as "disinflationary".

Given the high starting point, disinflation is still welcome as it means the negative impacts of inflation, for example diminished spending power and ever spiralling wage demands to keep up with inflation, are cooling. 

Which brings me to my second point. Whilst the disinflationary process has begun, inflation remains too high. Certainly, it's way above the Federal Reserves preferred 2% p.a. target, and they have been both very vocal and very active in trying to bring it down. 

After all, inflation imposes a substantial tax on the economy. Unlike government taxes, inflation a tax which very, very few benefit from – and this is why the Fed wants it down, and down quickly.

Us interest rates vs inflation CPI
click to enlarge image

So, Wednesday's inflation data will be very closely watched by the markets for further signs the rate of price increases in the US economy is dissipating. Consensus among economists is for a monthly rate of inflation for April of 0.4% to keep inflation for the 12 months to April steady at 5% p.a. 

Speaking in terms of annual rates, looking at the April CPI data due Wednesday, anything from 4.9% p.a. and lower will be positively received by stock and bond investors. It will also likely be bearish for the US dollar as any substantially lower inflation print will reduce the need for the Fed to continue with its current rate hike cycle.

Conversely, anything from 5% p.a. and over will dash hopes rates have peaked, and therefore likely weaken stock and bond markets while simultaneously strengthening the US dollar. With each of the above scenarios in mind, there are few interesting ways traders may wish to trade Wednesday's CPI data.
 

How to trade Wednesday's US CPI data

If the CPI rate is better than expected, one of the biggest beneficiaries will be the NASDAQ. The NASDAQ index contains stocks which are pre-or-early earnings cycle, and therefore have a higher reliance on debt funding. This makes them particularly sensitive to interest rates. Lower rates, equals lower debt financing costs, and therefore higher profits and returns to shareholders.

Nasdaq Composite (COMP) technical analysis
click to enlarge image

ThinkMarkets NASDAQ 100 or "NAS100" gives traders the ability to trade long or short the top one-hundred NASDAQ companies. The chart shows the recent trend in the NAS100 appears to have switched from a long-term downtrend to an uptrend since the October 2022 low. 

Major resistance is being encountered, however, with 13715 a key upside supply point. This price would be a logical target should the NAS100 break higher out of the recent trading range between 12725 and 13300. Traders may wish to instigate longs in the NAS100 upon a positive CPI print to take advantage of a break towards 13715 with stops set below the last point of demand at 12937.

A forex trade which would also take advantage of a weaker than expected CPI print would be a long on the GBPUSD. The GBP is the strongest currency on a relative basis out of the majors against the US dollar and it stands to appreciate further if the CPI is lower than expected.

gbpusd chart pound vs us dollar technical analysis cable chart
click to enlarge image

The recent price trend in the GBPUSD is up, and even more importantly, the price appears to have successfully broken out of the range between 1.840 and 1.2448. Traders could look for longs targeting the next key point of supply around the April 2022 breakdown point at 1.30. In such a scenario, stops could be set under the last point of demand at 1.2435, or more conservatively below the next lower point of demand at 1.2344.

Alternatively, if the CPI print comes in hotter than expected trades which favour longs of the US dollar are likely to see some success. In this regard, I suggest looking at going long the USDJPY as the JPY is the weakest currency on a relative basis out of the majors against the US dollar and it stands to depreciate further if the CPI is higher than expected.

usdjpy technical analysis
click to enlarge image

The USDJPY is in a short-term uptrend which is part of a broader double (rising) bottom pattern across the major swing lows in January and March. It has retraced to the bottom portion of the recent trading range. Longs could target the top of this range around 137.91 with stops set below the last point of demand at 133.49.


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Lithium prices tumble again...how low can they go? (Try half!)
 
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