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US June CPI: To Confirm the Next Rate Hike?

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The consensus among economists is that inflation in the US fell dramatically last month. But that might not be enough to convince the Fed to desist from a rate hike later this month. The forecast also sees core inflation remaining high. The dollar could remain strong as investors keep pricing in more action from the Fed.

There is a near-unanimous consensus that the FOMC will vote to raise rates one more time at the July meeting. It would take a pretty large miss of expectations to dislodge that consensus. Where debate remains is on what will happen in September. More immediately, it could affect what the Fed signals about the September meeting when it meets later this month. (The Fed doesn’t have a meeting in August, which is when the Jackson Hole Symposium occurs.)

What could affect the market?

The main issue is that the Fed is still saying that it will hike by a total of 50 bps by the end of the year. The market doesn’t believe they will get around to doing that, and will hike only once now in July. The consensus is that the economy will underperform in the second half, which will cause the Fed to hesitate to keep hiking. Or the situation could become dire enough that the Fed will be forced to cut.

If inflation remains high, it might help convince more traders that the Fed will actually go through with its plans. But, there is a catch: The more the Fed hikes, the more the expectation for a recession. So, even if inflation is high, and traders start pricing in more hikes, the dollar might not gain all that much.

The move to the downside?

If inflation is lower than expected, then the market might feel vindicated about the Fed not going so far with the rate hikes. But that would also mean the US is more likely to escape a hard landing, meaning interest rates could remain this high for longer than the market currently anticipates. That could put a floor under the dollar, as yields further down the curve rise.

Last week’s jobs data came out with an important nugget: Average wages rose by 4.4% in June, which was faster than the 4.1% headline inflation for May. And June inflation is expected to be much lower than that. That implies that the tightness in the labor market is keeping price pressure higher, and could mean that the Fed needs to shift focus. So, even if inflation is coming down, the Fed might feel it still has to take action to make sure inflation keeps heading toward target.

What to look out for

US June headline inflation is expected to fall substantially to 3.2% from 4.0% in May. That’s still above the target rate of 2.0%, but evidently a dramatic improvement from last year. Where things are tricky is with the core rate, which is expected to remain sticky at 5.0%, down just three decimals from the 5.3% in May. While certainly trending in the right direction, it is significantly higher than the Fed’s target.

Markets are likely to focus more on the core rate, because that’s what the Fed cares more about. A larger than expected drop could strengthen the consensus that there won’t be a rate hike after July. A beat of expectations could lead to worries that rates will keep rising, and a recession is more likely.

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