The Trade Idea Generation behind the Long EURUSD on USA CPI

The market is chaotic right now! We’ve seen PPI and CPI behaving completely erratically. On one side, PPI came in much higher, and the USD Index dropped as if there were no tomorrow. Then, yesterday, the CPI came in lower, and the market continued to drop. Something is wrong, isn’t it?

Well, it’s not! This is called a market change. One thing we need to understand is that the impact of economic news on currencies isn't straightforward - it's all about the context. What makes a currency stronger one day might drag it down the next. Smart traders don't just chase after the latest news; they keep an eye on the broader picture.

By staying informed, looking at how things have played out in the past, and being ready for different possibilities, traders can navigate the tricky waters of the market more effectively. Remember, it's not just about reacting to the news; it's about understanding the whole story.

So, if you’re not on my Telegram group (Here is the link to join it now: https://t.me/+bkfmaA76P2VlMTQ1 ), I will break down my thought process of why I thought that the CPI would have a strong chance of coming in lower, starting with the following points:

1. Slowdown in Rent Inflation: Analysts, including Standard Chartered's Chief Currency Strategist Steven Englander, foresee a significant reduction in Owners’ Equivalent Rent (OER), a critical component of the CPI. Regression analysis predicts an average inflation of only 0.29% month-over-month in the second quarter for OER, which is substantially lower than the 0.48% observed in the first quarter of 2024.

OER (Owner Equivalent Rent) 

 Source: Macrobond, Standard Chartered Research2. Political Impact on Rate Cut Expectations: With the approaching US presidential elections and political statements indicating a possible rate cut by the Federal Reserve before the year's end, there's an expectation that inflation will need to decrease to justify such cuts. This may influence how data is presented or perceived, leading to a potential negative surprise in the report. We can notice this by observing Powell's confidence in delivering a dovish speech at the last FOMC meeting on May 1st. We also have Yellen and the BoJ intervention: what timing! 

CPI Shelter Inflation

 Source: Zillow, Yardi, Department of Labor, Goldman Sachs Investment Research3. Lagged Data and Random Fluctuations: The experimental data used to estimate the OER are based on a small sample of rented single-family homes and are collected quarterly. This can lead to random fluctuations in monthly data, resulting in estimates that may not fully capture current trends in the rental market.

4. Disconnection between Real-Time Metrics and CPI Data: There is a significant lag between real-time metrics in the rental market and their representation in the CPI. Currently, even if rents are starting to rise in various parts of the country, this will not be reflected in CPI data until 2025, which may result in lower-than-expected numbers for the upcoming months.

OER carries a weight of 33% in the core CPI, so a decline of this magnitude (from 0.48% m/m to 0.29% m/m) would reduce the core inflation by 0.06% m/m, meaning that this variable alone would push the core estimate from 0.3% to 0.2% (if not lower). If a few more items come in colder than expected, we could have an even colder reading.

On Monday, Federal Reserve Vice Chair Jefferson adopted a hawkish stance, emphasizing the need to keep rates in restrictive territory until there is clear evidence of consistent inflation reduction. He emphasized the importance of clear and cautious communication to avoid misunderstandings and generate market certainty. "The continued emphasis on observing and responding to inflation reflects a firm policy against persistent inflationary pressures, reiterating the Fed's commitment to stabilizing prices and sustaining economic progress.

Now, having all of this in hand, we can understand why the CPI came in lower, because the rental prices as well as energy prices are dropping in the USA. But just a reminder is that this data is easily able to be manipulated. I’m not saying it was, but there is a high probability that it has been, as elections are looming, and Biden needs to maintain his good reputation. Therefore, working with the Central Bank is a good option. But another reminder is that the Fed claims to be an “independent institution,” meaning that they don’t take anyone's opinions or demands or rely on third-party opinions to act on the monetary policy of the USA.

Having all of this in hand, the only position that makes sense for me is the EURUSD long, as the EUR still has some strength despite inflation coming in lower in Europe. But compared to the USA, the GDP there is much better. You can access this link to have a look at my previous post where I talk about the GDP comparison of Europe and the USA: https://acy.com.au/en/market-news/market-analysis/eurozone-growth-weakens-usd-continued-expectations-reflect-trend-l-s-100720/

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