The dollar has gained substantially after Friday’s Non Farm Payrolls blew all expectations out of the water. As a result, the market has made a major shift in its projections for the next Fed cuts. The next data coming out on Wednesday could either shift the dollar back, and erase the gains, or push it even further higher.
There is considerable uncertainty about what the Fed will do in terms of rate policy this year. Part of that is the notorious unpredictability of a Trump presidency. But another part is that inflation has been rising after the Fed made an accelerated move towards easing. Some economists argue the Fed was too late to cut and needs to ease more before the economy slows down even more. Others argue that the Fed eased too much, too soon and another spike in inflation is coming. Mediating those two factions is the data that’s about to come out.
How Much Cutting to Expect
The next FOMC meeting is generally considered a done deal, with practically everyone expecting a hold just days after Trump takes office. What’s moving markets is the interest paid on the two-year Treasury bond, which is the most sensitive to future interest rate moves. If the market expects more rate cuts, then the yield will fall and the dollar with it.
Up until the jobs data, the market was pricing two Fed cuts for the rest of the year. That’s a substantial slowing of the pace to just 50 bps in a whole year, compared to 100 bps in just four months. Now the market is predicting just one rate cut this year. Even so, over 30% of participants believe that there will be no rate cuts. And there are even some economists talking about the possibility that the Fed will have to raise.
What Could Move the Market
Both the Fed and the markets expected inflation to pop up a bit around the end of the year, and then subside. So the fact that inflation is going up a bit now by itself isn’t the major concern. The issue is if inflation rises faster than expected, and this could trigger worries that consumer prices are escaping the Fed’s control. A faster economy, tariffs, rising fuel prices, colder than expected weather, all contribute to potential upward pressure to inflation.
But if inflation underperforms, it could be a sign that the downward slope of the end-of-year inflation bump is hitting earlier. That could get markets back to pricing in two rate cuts by the Fed, and erase the move seen over the last few days.
What to Look Out For
First on Tuesday is the release of Producer Price Index (PPI) figures. This is getting increased attention as they can often forecast whether there will be more inflation pressure as business pass added production consumers. The expectation is that the annual PPI will accelerate to 3.3% from 3.0% prior. But the core rate, which provides a better look at the long-term trend, is expected to advance at a slower rate to 3.5% from 3.4% prior.
Then on Wednesday is the release of the main inflation figure, which is expected to have increased on higher food costs around the holidays. Headline US December CPI is forecast at 2.9%, up from 2.7% prior. But the core rate, which is more closely followed by the Fed, is expected to remain unchanged at 3.3%. A larger beat in the headline number might not scare the market so much if the core rate remains steady. But a bigger move could be seen if both the headline and core rate miss, which would be a major surprise for the economists and market.