USD/JPY heading to 130?

After Wednesday’s post-CPI dump, the dollar managed to rebound a little as a couple of Fed official spoke about what the drop in inflation meant for monetary policy, before heading lower again ahead of the publication of US PPI later on Thursday’s session and UoM’s Consumer Sentiment and Inflation Expectations surveys on Friday.

With the odds of 75 basis point hike having dropped, the Fed is careful not to push too hard against that, but at the same time leave the door open for such an aggressive hike should incoming data from now until mid-September show another upsurge in prices or if employment once again proves to be too hot.

There’s plenty of time left until the FOMC’s September 21 meeting. This means that the dollar will not go up or down in a straight line but will continue to be driven by data and commodity prices as investors attempt to figure out the Fed’s next moves.

More bearish price action for USD/JPY

Following the CPI report, the USD/JPY turned sharply lower from around the 135 handle, where the significance of that psychologically-important level and that of the 50-day moving average provided strong technical headwinds. The U/J is now stuck inside a bear channel and with support at around 133.00 broken, the path of least resistance is to the downside. From here, a potential drop to take out liquidity below the previous week’s low at 130.39 is likely. Given that the next big round handle at 130.00 is less than 40 pips below that level, I reckon we will see a potential drop to 130.00 in the coming days.

Debate about 50 or 75 bp hike will continue

As mentioned, this won’t be the end of the 50 vs 75 basis point hike for the September meeting. In response to the inflation report, San Francisco Fed president, Mary Daly, said that the what the Fed needs is not necessarily a "good report on inflation," but as series of data showing the Fed is moving on "a path to bring inflation down substantially and achieve our price stability target".

Like Daly, the Fed’s Charles Evans wasted no time as he came out on Wednesday and said the July inflation data is the first positive report, but that further rate rises were warranted this and next year, predicting that the Fed Funds to top out around 4 percent. Though the probability of another 75 basis point hike in September has fallen sharply, the debate about 50 or 75 bp hike will continue for sure, and the Fed will be keen to keep that debate going until we get the next CPI and employment reports.

Next up: US PPI and Jobless claims

Now that we know July was a strong month for employment, but not so strong for inflation, investors will look for signs on how the American consumer’s outlook is shaping on the economy and inflation prospects.

First up, headline PPI is expected to print 0.2% month-over-month for July, compared to the 1.1% increase we saw in June. Core PPI is expected to show another 0.4% monthly increase. It is also worth keeping an eye on jobless claims which will be released at the same time as PPI at 13:30 BST. Claims have been ticking higher over the past several weeks. They are expected to show an increased of 4K to 264K from 260K the previous week.

If the above data come in weaker, then this should help accelerate the selling in the dollar as the odds for another 75 basis point hike drop further. The opposite is also true, although I don’t necessarily expect to see a big positive reaction to today’s data releases.

Coming on Friday: UoM Consumer Sentiment

Friday’s release of the University of Michigan’s closely-followed Consumer Sentiment and Inflation Expectations surveys will become in sharp focus after the above data releases are out of the way. Thanks to soaring prices of everything from gas to food, consumer sentiment in the US has been dropping rapidly in recent months, mirroring the situation in Europe and the rest of the world. However, the US economy has weathered the inflation storm better than other regions, which is why the dollar has until recently been so strong. But is the momentum changing? If we see signs of a struggling US consumer, then this could hurt the dollar further.

Consumer inflation not so hot

As a reminder, the CPI report showed a welcome relief in that price pressures have started to weaken, but more data is now needed to convince the Fed that inflation is on a downward trajectory. Driven by sharp declines in energy and gasoline prices, the 8.5% annual inflation read was relatively sharply weaker from 9.1% recorded in June. It is still uncomfortably high, but investors will take some comfort in that it was the first headline CPI reading that came in below expectation in 11 months.