FX Implications Of A High CPI From Citi

If Citi is right, and it is, and CPI comes high, and it will, looks for some fireworks in FX following the announcement of CPI in 5 minutes: "Market is most sensitive to core CPI reading as that is the Fed's target (at least the Fed majority's). Consensus and Citi are at 0.2%m/m  on core, but there are many more at 0.1% than at 0.3%.  Given how yields have moved in recent days the pain is on an 0.3% m/m rather than an 0.1%. The 0.3% would probably cause fear that the Fed will raise rates sooner rather than later while the 0.1% would be in line with a Fed hick in 2012. High core CPI would be a risk off event but USDJPY would see some upside support. If equities sell off it would be an added USD positive, since market is short USD and long risk, and rates unwind would lead to USD-supportive position cutting. On headline expectations very much in 0.4/0.5% range. A big overshoot on headline and core at expected 0.2% would probably have a modest and possibly temporary affect on US rates."

And some more views on the AUD and EUR following last night's surging Chinese inflation numbers, again from Citi:

The Chinese GDP data suggested that the economy expanded by 9.7% inQ1, more than market expectation of 9.4%. The CPI release further indicated that headline inflation intensified by more as well to 5.4% - the highest level in three years.

The fairly upbeat Chinese GDP data failed to spark a renewed enthusiasm for risky assets. Asian stock markets, commodity prices and G10 currencies like AUD and EUR came under slight downside pressure following the release.

One reason for that could be that the real news in the data was the fact that the Chinese headline inflation continued accelerating despite the repeated measures to contain its rise. Part of the market reaction thus reflects concerns that further inflation acceleration will be met with (potentially excessive) monetary tightening, which could slow down future growth.

The above conclusion seems to be confirmed by the slight upward correction in CNY NDF rates on the back of the release highlighting market expectations that the appreciation of the Yuan could slow going forward. The fact that the Chinese reserves grew to a record in Q1 also seem consistent with the view that the Chinese authorities will continue actively working against further pronounced gains in their currency for now.

If investors’ concerns about the potential negative impact of inflation on growth EM Asia intensify this could erode some of the support for currencies of export driven economies like AUD and, indeed, EUR in coming months. Commodity block currency should be impacted as well since a (temporary) slowdown in the main growth center of the global economy could weigh on the commodity prices.

Importantly, under this scenario, the support for liquid dollar alternatives like EUR and AUD coming from USD-recycling could ease as well due to diminished need for EM Central Bank intervention if the market pressure on their currencies to appreciate against USD comes to a temporary halt.