FX Market: Inflation Week Puts Focus on Gasoline Prices

Now with central bank decisions out of the way, the market turns its focus back on economic fundamentals. And once again, consumer prices will emerge as the one big report that everyone will be targeting. The reason for this is simple: Although central bankers have already made their rate decision for the month, traders want to know what is stopping them from either cutting or hiking rates in the next round?

A perfect example of this has been the recent turnaround in bets made on the Federal Reserve?s decision. Plagued by housing sector weakness, the Fed Fund futures at one point had priced in up to two interest rate cuts this year. The latest surge in gasoline prices however has caused the fixed income markets to expect no movements this year. In fact, positions in short 2-year treasuries have hit record levels, indicating that many people are betting rates will remain at 5.25 percent. Whether these theories are true will be dependent upon strong consumer prices in the month of April.

Gas Problems are a Domestic Issue

In our earlier piece on producer prices and retail sales, we have already taken a look at the recent trend of gasoline prices in the US. It is important to revisit this chart as we look to consumer prices because it not only sheds light on how US CPI will fare, but also on how Eurozone and UK CPI may be released later this week. The record high in gasoline prices in the US is predominately a domestic issue. Several refineries in the West Coast have been taken off line due to accidents while strikes in Europe have increased the import cost of oil. For the US consumer higher gasoline prices mean less money to spend. Even as wage earnings grow at an annual pace of 3.7 percent annually, consumers will be reluctant to spend disposable income, if they don?t have any. Last week?s retail sales numbers give plenty of credence to this idea, as the report actually fell 0.2 percent, the most since September according to the US Commerce Department. Incidentally, the annual rate of growth pales when compared to recent action in gasoline futures. By now, it is common knowledge that delivery at the pump has reached a record $3.07 a gallon. What many people may not know is the fact that advances in futures contracts of the commodity, the basis of all pump prices, tell an even gloomier story. Most recently, gasoline contracts have soared to $2.3521 a barrel on the New York Mercantile Exchange. This represented a 6.1 percent increase for the week of May 11th, powered by a previous 4.3 percent advance at the tail end of the week. Taking all of this into consideration, contracts for the commodity are now up an incredible 48 percent since the beginning of the year, far above what Mr. and Mrs. Jones made on the job. Gasoline prices will not only hit headline CPI, but also possibly core prices as many businesses may start adding gas surcharges to the bill once again. Stronger inflationary pressures will validate the Fed?s decision to remain hawkish, which would be dollar bullish.

What about Inflation in the Rest of the World?

Since record gasoline prices are mostly a domestic issue, we may not see higher inflationary pressures in the rest of the world. The UK has already reported softer PPI numbers. CPI for both the UK and the Eurozone is due later this week. The strength of the British pound and Euro should also help to alleviate inflationary pressures. Both the Euro and British pound have gained 6.2 and 3.1 percent respectively since the beginning of the year. Oil is priced in dollars, so the added purchasing power is helping consumers in both regions to be less sensitive to higher gasoline prices in the US. Based upon this, even though we could see stronger inflationary numbers in the US this week, we should see softer UK and Eurozone CPI, which would be bearish for the British pound and Euro.