Talking Points:
– EUR/USD slides through key $1.0800/50 as EZ CPI disappoints.
– Commodity bloc FX front and center the rest of the week.
– See upcoming event risk for FX markets.

Weak economic data from across the globe – particularly China and the Euro-Zone – has the US Dollar on stronger footing ahead of key event risk this week. Despite some alarming signs coming from the US economy (soft consumption figures, mixed housing data, and recession-level industrial production), investors and traders alike remain focused on ‘the big picture’: how fast will the Federal Reserve tighten policy this year?

With the December FOMC minutes due on Wednesday and the December US Nonfarm Payrolls report due on Friday, market participants – short- or long-term in nature alike – will have a fresh look at where the Fed stands. The key questions to be answered are:

– Why did the Fed reduce its 2016 inflation forecast yet hold its expected policy glide path for 2016? (FOMC minutes)
– Are Fed officials concerned about ongoing US Dollar strength to the point it could be a deterrent to additional tightening? (FOMC minutes)
– As the US labor market recovery matures and the Fed lifts off, will jobs growth hold firm or sag? (NFPs)
– Are recent gains in employment sufficient to continue to push down the US unemployment rate or has the US economy already reached “full employment?” (NFPs)
– Is wage growth accelerating enough to give the Fed confidence in a later rebound in inflation? (NFPs)

While we won’t get the answers to these questions directly, parsing the FOMC minutes and reviewing the details of the December labor reports should help provide enough clarity for judgement to be made on “who is wrong”: either the market, currently pricing in two rates hikes for this year (via Fed funds futures); or the Fed, currently suggesting it will hike rates four times this year (via the December ‘dot plot’).

Chart 1: Fed’s Dot Plot as of December 2015

These data and events matter insofar as the context of current market prices. The USDOLLAR Index may be consolidating in a two-month long bull flag, and should the FOMC minutes come in more hawkish and NFPs meet or beat, for example, this could prove to be a significant factor in pulling forward the market’s rate expectations, even if just from two to three rate hikes this year.

This would be a bullish catalyst for the USDOLLAR Index otherwise not yet unlocked. Conversely, without signs that economic momentum and confidence among officials is carrying over into 2016, the USDOLLAR Index may once again struggle to break out of its recent sideways pattern. Risk management throughout the week is paramount, of course.

In the event that the FOMC meeting and the US NFPs prove to be supportive of the US Dollar, it will likely come at the detriment of higher yielding currencies and risk-correlated assets. Any signs that the Fed could tighten policy faster than currently expected, against a backdrop of rising tensions between Iran and Saudi Arabia as well as Chinese/EM growth concerns, would seem like a caustic mix of influences for the commodity currency bloc in particular.

Read more: A Good Trader Always Seeks to Improve – Our Top Lessons of 2015

See the above video for technical considerations in the USDOLLAR Index, EUR/USD, AUD/USD, NZD/USD, GBP/JPY, AUD/JPY, and NZD/JPY. Also, read about my trade of the year: short GBP/JPY.

— Written by Christopher Vecchio, Currency Strategist

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com
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Source: Daily fx