30/09/2014: Concerns over Eurozone core CPI leading to further US dollar strength

The rate of inflation is not something that can be quickly dealt with through shifts and tweaks in monetary policy. The impact of today’s monetary policy changes would tend to filter through to inflation between 12 to 24 months later. Therein lies the problem for the ECB and why many people believe that they are behind the curve.

Today’s flash Eurozone inflation data for September showed that the Consumer Prices Index had dropped to 0.3% which was the lowest since October 2009. The move had largely been forecast by the market, but it was the core CPI (that strips out food and energy) dropping to 0.7% (from 0.9%) which has caused the big concern. Declining commodity prices can only be blamed for a certain amount of the disinflation (falling inflation), so clearly more needs to be done by the ECB. I imagine that Mario Draghi will be once again preparing himself for a further grilling on the ECB’s stance on Quantitative Easing purchases of sovereign government debt.

In the wake of the CPI data, EUR/USD has been slammed again. A drop of 80 pips on strong volume since the data continues the selling pressure. The breach of the November 2012 low at $1.2660 takes the euro to a 2 year low, but there is a more important implication. The November 2012 low was the last key reaction low until all the way back to the July 2012 low. I have already said that the bearish pressure for a full retracement back to $1.2040 was on following last week’s breach of teh 61.8% Fibonacci retracment at $1.2750, however the loss of $1.2660 now just confirms what I believe will be the medium to longer term move.

Selling rallies on the euro remains the only viable strategy. However, expect the volatility to continue through the week with the manufacturing PMIs tomorrow, the ECB monthly meeting on Thursday and finishing the week with Non-farm Payrolls on Friday. This may well lead to further weakness to come this week.

The big beneficiary of this euro weakness has been the US dollar. The dollar had been threatening a near term correcting, but the sell-off on the euro has benefited the dollar across the forex majors. The Dollar Index is once more through the roof and bursting higher.

DXY   30092014

Cable is down 50 pips (0.3% lower), back below $1.6200 again and is threatening a test of the key reaction low at $1.6160. If the low posted on 16th September is breached then the way is open for another go at the recent low at $1.6050. Th outlook for Cable is increasingly of concern. Dollar/Yen is another major pair that has seen a complete turnaround this morning. With a correction threatening, the rate has bounced to now eye a test of yesterday’s high at 109.74. A breach would re-open towards the breakout target of 110.65.

European equities have been supported by the CPI data as it makes the ECB more likely to engage QE, which would help to drive risk appetite, which is subsequently a driver of gains in equity markets. The DAX Xetra has been extremely volatile in recent sessions, but the gains seen today still have much to do to turn the outlook positive once more. The French CAC 40 is even more positive today, with a rebound of 1.0%, however the big laggard is the FTSE 100 which is trading marginally lower.

Finally, the dollar strength is once more having an adverse impact on the precious metals. Silver is trading 1.7% lower, as it continues on its way towards an implied downside target at $16.70. The gold price has fallen below the support at $1206.85 and looks as though it may complete is implied downside target at $1200 in due course. I still expect the gold price to pull back towards a test of the December 2013 low at $1184.50. With daily momentum indicators turning lower and there is little to prevent this from happening currently.

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