Jump in CPI Could Rally Yen (page 1 of 2)

US Dollar

After yesterday's extensive dollar sell-off, the greenback licked its wounds and recuperated some of its losses. For the second day in a row, it was the 10am (EST) numbers that moved the markets and not the earlier 8:30am figures. The earlier figures were mixed giving the markets no clear direction. Personal spending fell short expectations, increasing by only 0.9 percent last month while spending in December was also revised lower to 0.7 percent.

Personal income on the other hand grew by the fastest pace since September and came in stronger than expected. The trend of spending more than we earn has been a nasty habit of US consumers. For the third consecutive month, Americans have tapped into their savings to finance their spending. The savings rate fell to -0.7 percent in January from -0.4 percent in December and has not been positive since March 2005.

With the housing market showing signs of slowing, mortgage applications dipping lower last week and construction spending growth slowing significantly last month, we wonder how much longer this behavior can last. The only hope is that the labor market continues to grow strongly, which would give consumers the confidence to continue spending.

For inflation watchers, the tick higher in the PCE deflator may have been encouraging, but a closer look reveals that he acceleration in core prices remained relatively tame. Slow inflation growth is further confirmed by the prices paid component of the ISM report, which dipped from 65.0 to 62.5.

The actual index itself jumped from 54.8 to a more than expected 56.7, which is the primary reason why the dollar rebounded. After yesterday's dismal Chicago PMI number, market expectations were notched down significantly for the ISM report. An in line number would have probably been enough to cause a rally, which means that market took the better number as cause for celebration.

However, we remain cautious about celebrating prematurely since many other numbers released over the past 2 days gives the Federal Reserve reason to refrain from overshooting interest rates and instead, stop at 5.00 percent.

Euro

Tomorrow is central bank day in Euro-land. The European Central bank has kept us waiting 3 months now for another rate hike and after much anticipation the market has pretty much discounted a quarter point move.

We have talked all week about the wild card at tomorrow's meeting which will undoubtedly be the accompanying comments made by ECB President Trichet. The market expects him to continue to signal steady interest rate hikes, possibly on a quarterly basis.

Therefore if he is far more hawkish, we could see a pop in the Euro. Some traders have also been entertaining the notion of a 50bp rate hike instead of a 25bp hike tomorrow, but we think this is highly unlikely. Given the ECB's cautious nature and the region's dependency on exports, they are not likely to risk a hard earned recovery.

Economic data released this morning continues to be very bullish for the Euro. Manufacturing activity accelerated in Germany, France and Italy while unemployment was revised lower to 8.3 percent from 8.4 percent. Even though the CPI estimate fell from 2.4 percent to 2.3 percent, it still remains above the central bank's upper limit which reinforces expectations for more rate hikes to come.

British Pound

After being the biggest over performer yesterday, we had hoped to see an extension move that would validate a reversal in the British pound against the US dollar.