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Concerns over rising inflation and rising interest rates spooked the markets last week and sent global equities on a roller coaster ride. Following the release of a better than forecast US jobs report, which showed US earnings grow at the fastest rate since 2009, US treasury yields quickly climbed higher, hitting a 4 year high of 2.9%. Meanwhile, the Dow & the S&P 500 tumbled into correction territory, after losing over 10% since the recent high just three weeks ago. Whilst there are tentative signs of the markets stabilizing, it is still too early to call the bottom with most investors watching the CPI release from the US on Wednesday before making their next move.
Given the back drop of last week’s market action, Wednesday’s CPI release at 13:30 GMT (08:30 EST) and US retail sales will be some of the most closely watched economic indicators in recent times, as market participants desperately try to make sense of the huge sell off in stocks and bond markets. The market could be more sensitive than usual to the CPI release.
Headline CPI is forecast to dip in January to 1.9% year on year, from 2.1% in December. Meanwhile core inflation, which excludes the more volatile items of food and fuel, is forecast to drop to 1.7% year on year in January, down from 1.8% in December.
Should we see a sudden pick up in prices then this would confirm traders fears that inflation is actually moving at a faster pace than what the markets had been expecting. Fears could amplify that the Fed could look to hike interest rates more aggressively through the year.
The overriding concern is that if the data surprises on the upside and inflation is higher than forecast, we could see a repeat of last week rout. Perhaps not as extreme as last week, but traders fear another heavy sell off, which could pull the US indices back into correction territory.
On the other hand, should we see a figure that is roughly in line with expectations, the data could actually have a soothing effect on the market and help this recent spike in volatility settle down.
Potential Market Reaction:
Going into the release the market has fully priced in two rate hikes by the Fed and sees a 40% probability of a third hike, according to the Fed Fund Futures. Higher than forecast inflation, could increase the probability for a third hike this year and lift US treasury yields. Higher yields tend to boost the currency, so the dollar would also be expected to rally. USD/JPY could look to break through 108.00 and target 108.50, before potentially opening the door to 109.30.
Higher yields could also weigh on the US equity indices, especially given the performance of the Dow and the S&P over the past week. A move southward by the Dow could test support at 23,780 before extending losses towards Friday’s low of 23,350.
On the other hand, weaker than forecast CPI readings could provide some much-needed respite for the US indices and have a calming effect on the market, potentially helping to settle the recent spike in volatility. In this scenario we could see the Dow look to test resistance at 25,300 (high of 7 Feb) before pushing on towards the 25,700 (low Jan 16). Meanwhile in the forex markets the USD/JPY could look to extend Tuesday’s sell off beyond 107.30, potentially even targeting 106.80.
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