The Trade Week Ahead – Inflation

Inflation

Never forget that inflation is the one thing that keeps a central banker up a night. They may talk about employment and GDP and the like, but inflation (either hyper or hypo inflation) is the stuff of nightmares.

Therefore the 2 main economic events on the inflation front this week are:

– US: Personal Consumption Expenditure (PCE) (look to the core read) – No nightmares yet, but US inflation has the potential to rapidly extend upwards. There has been some in the market that have suggested that the Fed has been too slow to increase rates as inflation is likely to ran pass the target rate. A snap upside movement would put pressure on its ‘gradual rate path’. The previous read from August was a surprise PCE slowed to its lowest level in 18 months. However the year-on-year figures still show that US PCE is at or near the Federal Reserve’s target of 2%. The consensus Monday nights read is YoY to remain at 2%, which will justify with the Fed’s current policy path of raising rates – if it pops pass this, the market will jump on the USD.

– Australia’ Consumer Price Index (CPI). I suspect Philip Lowe and co are starting to understand the meaning of insomnia – the core mandate of the RBA is to maintain trimmed mean inflation between 2% and 3%. Since the third quarter of 2015 the core measures of CPI haven’t touch this level and until last quarter trimmed mean CPI had flatlined at 1.8% for six consecutive reads. Q2 did have some green shoot movements and seeing CPI increasing to 1.9% year-on-year. The reasoning; the employment boom has finally begun to eat into the employment slack and wage were beginning to shift. However the issue facing the RBA is housing; this has been a key driver of CPI. The change in housing in the third quarter is likely to be negative suggesting core inflation will spend another quarter below the target band and could even suggest its moving away once more, AUD I believe will suffer on Wednesday’s release.

One has to ask, is the RBA’s glass third quarters full view of the economy justified? There are three macro thematic issues facing the RBA’s neutral-Hawkish view.

1. Housing and bank funding, housing market is already on the slide and global funding feed-throughs will market credit expensive over the coming 24 months – it could turn the RBA dovish.
2. China, the RBA is starting to acknowledge that the growth profile into China is slowing and again that could see the ¾ view shifting.
3. AUD, the currency is in its favour currently however it has made no secret it would like it lower still. I have been very bullish on the USD for the last 18 months. However most strategist believe the USD appreciation will slow and could even reverse in the coming few quarters making Australian exports less competitive again – Another possible rethink.

In short the RBA’s current stance although understandable could shift to dovish pretty quickly – the trade therefore is short AUD.

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