At the moment, just under three quarters of traders are expecting the Fed to hike at the next meeting, and the remainder expect a pause. There was a substantial shift in those expectations following the March jobs numbers. Before, the expectations were around even between a cut or a pause. Tomorrow’s data could potentially shift those expectations substantially again. The market pricing in that change could move the dollar, and the commodities priced in it.
The jobs numbers reported on Friday were interpreted as being better than expected, even though the headline figure was pretty much in line with forecasts. This is because the underlying components showed a negative adjustment in birth-deaths, suggesting the real number would have been higher. In all, the jobs number hammered home that there was still tightness in the labor market, and the latest episode of bank issues had not immediately affected the economy.
Wednesday’s data could change all that
First to be released is the inflation figures, which are once again heading in different directions. This could temper the market a little bit, since the reaction to the headline figure is different from the core rate. Overall CPI is a factor for investors when it comes to calculating the ROI of buying bonds, while the core rate affects expectations for monetary policy, because that’s what’s tracked by the Fed.
Headline CPI change is expected to come down to 5.3% annualized from 6.0% prior, with the monthly rate decelerating to 0.3% from 0.4% prior. The core rate, on the other hand, is expected to stay at an annual rate of 5.5%, with the monthly rate decelerating by a decimal point as well.
The market reaction
A lower headline rate in effect increases the real yield of bonds, making them more attractive for investors. When deciding where to put your money, you need to not only consider the interest rate paid, but also how much you will lose due to inflation over the same period. If inflation is lower than expected, this could mean that it can keep descending at a higher rate, increasing the expected real yield in bonds, and in turn supporting the dollar.
On the other hand, if the core rate remains high, then the Fed is more likely to raise rates to get inflation down. If the core rate were to unexpectedly fall, it could weaken the consensus that the Fed will hike, and by extension weaken the dollar. This is one way in which the inflation result can either reinforce the dollar, or create increased volatility as traders re-price expected inflation compared to expected rate policy.
The FOMC minutes
In the evening, the Fed will release the minutes of the last FOMC meeting where they hiked by 25bps. The main factor traders are likely to be focusing on is how much the banking crisis of the time weighs on the decision. Since worries about the banks have diminished substantially in the meantime, if the Fed would have gone for 50bps if it weren’t for the SVB issue, then traders could price in a more aggressive Fed at the next meeting.
On the other hand, if the Fed was largely unconcerned with the banking issue and decided to hike by a quarter of a point due to the inflation outlook, then the chances of a rate hike might be reduced.
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