Inflation Could be the Dollar’s Worst Enemy

Economists were quick to poke holes in a strong US GDP report but it's the inflation picture that should be in the spotlight. The kiwi was the top performer Thursday as it defied RBNZ jawboning while the yen lagged. Up next it's the Japanese CPI report and the BOJ decision.  In the Premium trades, both  GBPUSD shorts were closed prior to reaching their final targets, attaining a combined  profit of at least 210 pips.  AUDUSD and NZDJPY shorts as well as longs in USDCHF remain in progress.

US GDP rose at a 3.5% pace in the preliminary Q3 report, beating the 3.0% consensus. The dollar jumped 30 pips across the board but the gains were almost immediately erased and the dollar continued to fall throughout the day.

What happened? Most economists pointed to the large boost in GDP because of US defense spending. That added about 0.6 pp. Others pointed to trade but that could continue to be a boost because of rising oil production. Consumer spending was also slower at +1.8% but it's a challenge to separate the effects of lower gasoline prices at the moment.

What was largely overlooked was the slowdown in inflation to 1.4% y/y compared to 1.5% expected and 2.1% in Q2. With commodity prices down, it's a challenge to envision any type of US inflation in the next six months.

The Fed flagged falling breakevens in the FOMC statement and 5-years are holding at 1.53% and 10 years have slipped to 1.90%.

Bank of England officials have been discovering that better growth and employment don't necessarily mean inflation as slack is slowly taken up and the Fed could soon be learning the same lesson. In Friday's PCE report, keep a close eye on the deflator.

But first, the focus will be on the BOJ. USD/JPY rose to a three-week high of 109.48 on Friday. The catalyst was a rehashed report that the GPIF will increase its domestic stock allocation to 25% in an announcement that will be formalized today.

But the larger announcement will be the BOJ at around 0200 GMT. But first at 2330 GMT it's the September CPI report. The national CPI is expected up 3.3% y/y with Tokyo up only 2.7% y/y for October. Stripping out the effects of the consumption tax hike, that's far below the BOJ's target.

And that's why 3 of 35 economists surveyed by Bloomberg are predicting the BOJ increases asset purchases Friday. Such a move or a strong hint at a future move would easily send USD/JPY through 110. If those headlines hit, jump on them and ride them for as long as you can.