Fed View May Be Inflated

The focus of the week ahead will be inflation and the picture is already forcing the Fed to change the channel on rate hikes. In early trading, USD/JPY has marched 33 pips higher while most other moves are subdued. Japanese GDP is up next.  USDJPY long hit its final 116.70  target for 210  pips. GBPCAD hit 1.7800 for 220 pips. USDCAD in progress.

October CPI is due in the US on Thursday and that will be the main talking point after the dollar rally sputtered last week (it was the worst performer outside of GBP and JPY). On Friday, the ultra hawkish Philly Fed President Charles Plosser said inflation won't be a problem, at least in the near term.

Meanwhile, economists at Goldman Sachs and BofA cut core inflation forecasts for 2015 to 1.5% and 1.4%, respectively.

Plosser and fellow hawk Fisher will both retire in Q1 2015 and that leaves Esther George as the lead hawk and she's switching tactics away from worrying about price rises to a focus on asset bubbles and financial excesses. On Saturday, she cited that as the main reason to raise rates.

The argument may not gain traction but even if it does, it has much different implications than hiking to curb inflation. If the Fed wants to encourage a bit of lending and bubble discipline it will likely end a hiking cycle at 1.00% but could go as high as 2.00%. In the event of inflation, the top could be 200-300 basis points higher.

As the argument shifts, it may cap longer-term US yields and that may stall the USD advance.

In the near-term, Japanese GDP data is due at 23:50 GMT. The consensus is for a 0.5% q/q rise but the impact on FX may be moderate with more BOJ easing off the table at the moment.