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US CPI: How Many Rate Hikes?

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At the end of last year US equities pushed higher, with the S&P 500 almost scoring a new record high. That came at the expense of a weaker dollar, helping the most traded pairs to rise. But the data that has come out since the new year has provided a counterpoint, and it could mean that the dollar is set to recover the losses.

The main driver of weakness in the dollar towards the end of last year was an expectation that the Fed would cut rates for a total of 150bps this year. Not only that, but that the first cut would happen in March. That was after the Fed insisted it would be data dependent this year, and admitted that rate cuts were on the table.

Getting Ahead of the Facts

The Fed only admitted to the possibility of three cuts, or 75 bps. That’s half of what the market is expecting. On Monday, FOMC voter Raphael Bostic doubled down on that tighter program, saying he saw only two rate hikes this year. And that would be at the end of the year, as well. His comments were especially notable, because he’s seen as one of the more dovish members. Presumably, the rest of the Committee who are more hawkish are even less reluctant to cut.

Coming off the heels of an NFP that came in stronger than expected, suggesting there is still tightness in the labor market, hopes of a rate cut in March have substantially faded. If US inflation figures were to beat expectations, then those hopes could completely melt away and even create the possibility of the market moving to pricing fewer cuts. That could give the dollar a substantial boost.

Let’s Not Forget the Pairs

Of course the dollar doesn’t trade in a vacuum. Its most common trading counterparts – the Pound and the Euro – are facing additional pressures as well. The ECB was also expected to cut rates 6 times this year. But the recent bump up in inflation has shaken confidence in those projections. Now with rising price pressure from the conflict in the Middle East making ships travel farther and at a larger cost to bring goods to Europe from Asia, inflation could remain on the radar for the ECB going forward.

In order to make gains, the dollar would have to overcome shifting expectations in Europe as well. If the data were to disappoint, then the market might seize on the figure as validation of the expectation that rates will come down faster than the Fed says. While that might help equities, it could mean that the dollar could resume its downward trajectory as yields on debt decline.

What the Data Could Say

The headline monthly inflation rate is expected to remain unchanged at 0.1%, with the annual rate also expected no changes at 3.1%. Where markets are likely to be more focused is on the core rate, which is expected to come down to 0.2% on a monthly basis from 0.3% in November.

What might have a more psychological impact than the real size of the change is the expectation that core inflation for December will come in at 3.9%, below the 4.0% of November. That would mean that core inflation no longer doubles the target rate.

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