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US CPI, Last Data Before Fed Meeting

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The US will release its latest inflation figures tomorrow. The consensus is that CPI will go up, but over 90% of traders see the Fed holding pat on rates when it meets a week later. What’s going on? In what ways will the data affect the markets?

The date also comes at a peculiar time for the markets. Bond yields have been trending higher at the same time as stocks have. Usually, those two indicators work in opposition. When yields rise, stocks go down, and vice versa. The connection to forex is that typically higher yields means the currency gets stronger. But that is based on the supposition that people aren’t piling into the stock market.

It’s all about expectations

With the vast majority of traders expecting no interest rate hike, the stock market has become more attractive for investors. That means the dollar has been underperforming in a set of circumstances when it would otherwise do better. That dynamic, however, could come to a screeching halt if the data coming out tomorrow surprises.

The Fed has said that it will be more data dependent. On the surface, this sounds like a generally good thing. But, it enhances the short-term thinking of the market, as it reacts to each data point instead of the overall trend. What that means for traders is that the markets can have a bigger reaction, even if there is a small surprise in the data. This could be especially relevant to the CPI figures tomorrow, which could end up pointing in opposite directions.

What the data could say

US headline inflation is expected to rise again in August to 3.5% from 3.2% in July. And we have to remember that was already an increase from the 3.0% in June, which has been the recent bottom. Inflation was expected to rise again because of base effects, but it caught a second wind thanks to higher gasoline prices. Fuel prices are at a seasonal, 10-year high, which could keep crimping American consumer spending.

Of course what the Fed cares most about is the core figure, which excludes volatile food and energy costs. That is expected to come down to 4.4% from 4.7% prior, and continue the downward trend it has maintained for months. On that basis, traders are expecting the Fed to keep rates steady at the next meeting. But if core rates surprise to the upside, then that consensus could change, and boost the dollar. A surprise to the downside, on the other hand, simply would confirm the outlook. A consensus of 95% as opposed to 93% isn’t a radical change that would move the dollar all that much.

The focus beyond

It seems that markets are already moving beyond the next meeting, with the focus on what will happen in November. Thus, what is likely to matter is whether the inflation data is out of line enough that will prompt Fed Chair Powell to be more forceful in saying a hike will happen at the November meeting.

Only 46% of traders see a hike in November. But, if headline inflation keeps moving higher, it makes it harder to bring down the core rate. If the rise in inflation becomes more persistent, that minority of traders expecting a hike should shift to a majority, and that would substantially support the dollar.

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