What Dollar Impact to Expect from US CPI and Is This Crypto’s Lehman Moment?

S&P 500 Leads Risk Retreat as Midterms Pass, Beware the Crypto Markets Feedback

There was little relief from the market’s distraction through the start of this week. Where the passing of the US midterm elections lifted one future milestone throttling speculative interests, the more ‘binary’ potential of the consumer price index (CPI) release Thursday effectively picked up the baton to keep speculative conviction in check. Yet, that event too will soon pass. In evaluating the sentiment tide leading into the top US economic docket listing Thursday, there was some notable – but nascent – traction to be registered from the S&P 500 through Wednesday’s session. The -2.1 percent drop was the first drop from the US index in four trading sessions. It would also come with the headwind in the form of an upswing in in the VVIX ‘volatility of volatility’ index. A further erosion continued in the ratio of the once-speculative favorite Nasdaq 100 (populated by the top market cap FAANG members) relative to the stoic Dow Jones Industrial Average. The NDX-DJIA ratio edged down to a fresh two-and-a-half year low through Wednesday’s close.

Chart of S&P 500 with Volume Overlaid with the VVIX Index and 1-Day ROC (Daily)

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While the dominant fundamental focus around ‘risk assets’ over the past weeks and months has reasonably focused on the fallout on monetary policy’s impact as well as the probability of recession moving forward, it is important to keep a wary eye open for the unexpected sparks that can ignite unforeseen financial fires. Just such an embryonic threat seems to be bubbling up through the crypto market. The news earlier this week that cryptocurrency exchange FTX was struggling under heavy customer withdrawals seemed to find balance when it was reported that Binance was stepping in to essentially rescue the struggling company. That reassurance fell apart, however, this past session after Binance withdrew its acquisition offer. The implications are not good. This unfavorable turn begs the question: how systemically important is FTX to the crypto currency. It is a large player, but the real threat is the potential for contagion in the space. Should stress tests heaped on other critical players in the asset class foster critical pressure, technical placement will matter little. As for what this means for the broader financial system, the fact that this happening in the crypto space matters little if it triggers a general panic in speculative appetite general. I don’t operate expecting grey swans, but it would be foolish to ignore the flare ups that seem as if they could readily escalate.

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US CPI and the Dollar’s Exposure to the Rate Implications

With the passing of Wednesday’s session, we have further put space between the market’s speculative focus and the US midterm elections. That doesn’t mean that the political landscape in the US is clear – in fact, the outlook for Congress looks to depend on some key recounts and possible runoffs. However, for its overall speculative influence, I believe the short-term potential for this event has come and gone (the long-term influence will likely play out for some time but over a more glacial pace). Yet, with the alleviation of the election distraction, we see the focus of the speculative rank shift to yet another scheduled event in the immediate future: the US October CPI. The economist forecasts call for a very modest moderation of the inflation clip. This indicator series carries serious weight given the FOMC this past week made its plans for extending the timeline and peak rate for its hawkish regime ambiguous after last week’s 75 basis point rate hike. That influence can make the event a meaningful market mover whether the actual reading beat or miss expectations.

Critical Macro Event Risk on Global Economic Calendar for Next Week

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When it comes to the market’s response to the inflation report, the impact is likely to stretch broadly across the financial system; but the Dollar is perhaps my principal focus. Below is the DXY Dollar Index chart which each of the past 8 months’ CPI releases highlighted. The direction of the market takes after the inflation update depends significantly on the direction and intensity of the data’s surprise. That said, the market response to the updates has tended to skew towards significance. Given the extended series of significant rate hikes and the Federal Reserve’s warnings that it would act principally to control price pressures, the potential for significant volatility around this event remains very high.

 Chart of US Dollar with CPI Release Dates, 100-Day SMA and 1-Day ROC (Daily)

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EURUSD and USDJPY: Differing Potential Should Inflation Stir Market Response

When it comes to evaluating whether the inflation statistics will beat, meet or miss expectations; I don’t presume to have a meaningful insight into how the data will print. As such, my approach is to scope out options for the different outcomes. In the event that the CPI reading meets expectations, the tempo on the headline (8.0 percent) and core (6.4 percent) would still be extremely high and likely default to an essential assessment of a hawkish reading. That would be a negative catalyst for ‘risk’ and benefactor for the Dollar. Assessing an S&P 500 or Dow bearish course is fairly straight forward, but evaluating a strong Greenback beneficiary is a different matter given the currency is not far from its multi-decade highs set last month. One candidate that seems well positioned is EURUSD, but not for the revival of its overall bear trend. Rather, a swing over its past 8 week range would seem feasible.

 Chart of EURUSD (Daily)

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To truly disappoint through the US inflation report, the slowing in the CPI would likely need to be significant. Something on the order of a 7.0 percent headline clip could certainly achieve that designation – though it is a more extreme scenario. Such a downgrade in inflation pressures could give the Fed scope to ease up on its inflation fight and shift its attention back towards a throttling of economic conditions. Yet, for the US Dollar, the implications could be a little more immediate and dramatic. Among crosses that would be more exposed to a dramatic and intense reaction to a Dollar retreat, I consider USDJPY the most disposed to action. There is a risk sensitivity to this pair, but the macro fundamental sensitivity is principally a reflection of the Dollar’s fortunes. Therefore, an earnest Greenback breakdown would be particularly charged here.

Chart of USDJPY with 50 and 100-Day SMAs with 20-Day ATR and Historical Range (Daily)

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