Wednesday sees the release of the last major US CPI data that could affect next week’s pivotal FOMC meeting. There is a pretty strong consensus now that the Fed will go through with its final rate hike of the year. The US CPI data figures coming out now are pretty much the last expected data point that could substantially change that perception. Remember that the Fed is under its pre-rate decision blackout, so the market will have to react to the data without any clarifying comments from officials.
Inflation is expected to keep picking up, but that’s in line with expectations from economists and from the Fed itself. Current monetary policy outlook assumes a small acceleration in inflation through the winter that will fall back off early next year. Markets are looking for an affirmation of that trend to lock in the pricing of monetary policy for the dollar and its trading pairs.
What to Look Out For
US November headline CPI is expected to come in at 2.7%, up from 2.6% in October. That would be an acceleration for the second consecutive month, pulling away from the Fed’s 2.0% target. This is despite the drop in the cost of energy, with the average gasoline price falling below $3.00/gal for the first time since 2021. Food prices are seen driving prices higher, among other factors.
The figure that is more closely tracked by the Fed is the Core US CPI, which is forecast to remain steady for the third consecutive month at 3.3%. The stickiness in this reading is being largely attributed to increasing prices of shelter, which could be a key factor for what the Fed does now.
How the Market Could React to the Data
Markets are pricing in a 90% chance that the Fed will raise rates at the next next meeting, which is up from 73% a week ago. That change is thanks to the NFP results on Friday. Although there were a larger than expected number of jobs added, this data is seen as less reliable and subject to important revisions. The unemployment rate ticking up was interpreted as a more reliable indicator that the labor market continued to loosen, which is what the Fed is looking at in terms of moving towards easing.
What that means is that it would take a substantial overshoot in the inflation data, particularly the core reading, to convince the market that the Fed won’t hike. Accelerating inflation might not change the outlook for the upcoming meeting, but could affect the outlook for the meetings after, and still pull up the dollar. On the other hand, if inflation were to underperform, that would be confirmation of the upcoming easing. With still 10% of a chance that a rate hike won’t happen, there is room for the dollar to weaken a bit if inflation undershoots the mark.
The Housing Problem
One of the potential wrinkles in the data is the shelter segment, because that ties more directly to the Fed’s actions. House prices and rents have been rising in the US, contributing to rising core inflation. The cost of buying a home is intimately tied to the interest rate, as lower rates means people can afford more expensive buildings. But higher rates also make rent prices higher, and slow new housing from getting on to the market, since it restricts builder’s borrowing capacity.
The market will likely be looking at the shelter component of the US CPI data closely, since the Fed could zero in on that at the next meeting as it tries to close in on its inflation target. Conventional understanding of monetary policy would suggest the Fed will be more inclined to hold rates higher if shelter inflation is the biggest component to keeping inflation up.
