How To Trade Today's CPI Release In FX: Goldman Explains

Markets are intensely focused on today’s US core CPI release. A softer print than consensus is likely to prove helpful to risk sentiment since it should reassure investors that inflation is likely to move towards target gradually. Equally, a firmer print could extend the recent period of market volatility.

From an FX market standpoint, Goldman looks at the specific crosses investors can use to position for a US core CPI surprise today. The bank focuses on the US CPI releases in 2017 – a period when market focus on these releases was especially acute – and identify the crosses that have seen the largest responses using intra-day data around each release.

Goldman's findings: in G10 FX, AUD, NZD and JPY have typically had the largest moves in response to core CPI surprises over the past year. Within EM, the most responsive crosses have tended to be MXN, TRY, ZAR and BRL among high-yielders and HUF among low-yielders. At the other end of the spectrum, some of the least responsive currencies tend to be INR and RUB in EM and GBP and CAD in G10.

Separately, the responses of the JPY and CHF may be dominated by the behaviour of risky assets and equities (which have been at the epicentre of recent volatility) rather than the direction of the CPI surprise itself. And, in the case of ZAR, the ongoing headlines around President Zuma’s position as head of state are likely to affect the market response.

As shown in the chart below, through 2017, the most responsive crosses to surprises in US core CPI were NZD, AUD and JPY in G10 FX, and MXN, TRY, ZAR and BRL in EM FX

Some more details from Goldman:

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FX Responses to Today’s All-Important US CPI Release

Markets are intensely focused on today’s US core CPI release. The stronger-than-expected hourly earnings data in the January labour market report catalysed market concerns about a faster increase in inflation and was one of the proximate sparks for the bond and equity selloff last week. So as the next data-point that updates the trajectory of the US inflation process, the intense focus on today’s print is understandable. Market focus on US CPI inflation has increased over the past few years as we move into the later part of the economic cycle in the US, and the prospect of higher inflation and more restrictive policy looms larger. Exhibit 1 shows the average percentage impact of a 1sd surprise in US core CPI on US Dollar crosses in a 30-minute window around each release. Coming into 2018, the FX market focus on CPI releases has been the highest in the past several years.

For today’s core CPI, our US Economics team expects a 0.22% increase in January core CPI (mom sa), which is a touch firmer than consensus expectation of a 0.2% increase. This should lower the year-over-year rate to 1.7% (from 1.8% in December). A softer print than consensus is likely to prove helpful to risk sentiment since it should reassure investors that inflation is likely to move towards target gradually. Equally, a firmer print could extend the recent period of market volatility.

From an FX market standpoint, a key question is what specific crosses investors can use to position for a US core CPI surprise today. To answer this question we focus on the US CPI releases in 2017 – a period when market focus on these releases was especially acute – and identify the crosses that have seen the largest responses. Specifically, we collect intra-day data – at a 5-minute frequency – for release dates of US inflation, and focus on a narrow window (starting 10 minutes before and ending 20 minutes after the US inflation release) around the release time. We then regress the cumulative returns in different (G10 and EM) USD crosses over this interval on the surprise in core CPI, defined as the difference between the actual print and the corresponding median consensus forecast from Bloomberg, scaled by the sample standard deviation. Exhibit 2 plots the estimated responses over these 5-minute windows for AUD and TRY, which suggests that by the 20-minute point, markets have typically experienced the maximum response to the core CPI surprise, after which the response tends to fade.

Exhibit 3 plots the estimated impact of a positive (or hawkish) 1sd surprise in US core CPI (around 10bp in the 2017 sample) on the cumulative return in different US Dollar crosses at the 20-minute point. Red lines denote the 90% confidence interval for each coefficient. The results suggest that in the G10 space, the antipodean crosses (AUD and NZD) along with JPY have typically had the largest moves in response to core CPI surprises over the past year. Within EM, the most responsive crosses have tended to be MXN, TRY, ZAR and BRL among the high-yielders and HUF among the low-yielders.

In general, the confidence intervals are large, reflecting the limited number of observations in the sample over the course of 2017, and particularly large for the JPY and ZAR. Further, the reactions in both these currencies could be complicated in the current circumstances. The JPY response is likely to be affected (and indeed dominated) by the behaviour of risk assets in general given its status as a ‘safe haven’ currency and in line with the sharp strengthening over the past 10 days. In a similar vein, there is some risk that the response in CHF is dominated by the behaviour of risky assets and equities (which have been at the epicentre of recent volatility) rather than the direction of the CPI surprise itself. In the case of ZAR, the ongoing headlines around President Zuma’s position as head of state are likely to affect the market response. So AUD, NZD or TRY, MXN are likely to be relatively cleaner ways to position for a core CPI surprise.

At the other end of the spectrum, some of the least responsive currencies tend to be INR and RUB in EM and GBP and CAD in G10 space. Although the confidence bands around these estimates are fairly large, these are probably among the crosses that have typically been less affected by US core CPI surprises in 2017.