Usually, we have all the key data points ahead of an FOMC decision to make a better evaluation of what could happen. But this time, the most important data for the Fed will be released during the first day of their meeting, later today. Then tomorrow the FOMC releases its decision.
Depending on what the data says, there might be a significant reevaluation of what the Fed will do tomorrow, and what it might signal for the start of the new year. Both factors are expected to be determinate for the market’s reaction, as it prices in expectations for where the rates will be in the coming months.
Another CPI surprise?
We should remember that last time around, the US CPI (for October) came in well below expectations. A look at the components showed that economists hadn’t considered just how much the price of housing had fallen that month. Since then, there hasn’t been a recovery in this item. Even the largest element to drive inflation, energy costs, has been sliding downward in the meantime, as crude prices come down over fears of a recession.
But, no one can say what the future will hold. Inflation coming in lower than expected is unlikely to change what the markets are expecting of the Fed. Even if there were a major miss on expectations (similar to last time), inflation would still be way above target.
What kind of surprises?
On the other hand, if inflation were to come in hotter than expected, but below the prior level, then the downward trend would still be intact. The Fed would still need to hike, because inflation is still too high, but slowing down the pace is understandable.
Where things could get interesting is if inflation were to come in above the prior level. The headline number doesn’t matter so much as the core figure. That would imply another break in the downward trajectory, and could lead to a reevaluation of Fed expectations. Both in terms of what the Fed could decide tomorrow, and what could come after that.
What to expect
Annualized headline inflation is expected to keep falling to 7.3% from 7.7% prior, aided by growth of 0.3% in monthly inflation. The key core inflation rate is expected to fall to 6.1% from 6.3% prior, and a beat by 3 decimals here could be what shakes up expectations.
75% of economists think the Fed will raise rates by 50bps at the next meeting. The remainder are betting on 75bps. But, Powell pretty much foreshadowed that it would be the smaller number – unless there is surprise in the data.
The key issue for the markets is where the Fed sees the “terminal rate” going. That is the maximum rate they will raise to during this cycle. Currently the market is expecting it to reach 5.0% sometime early next year. If the Fed implies the rate will be higher than that, it could lead to the dollar getting stronger.