Wednesday’s US CPI figures will be pivotal for the markets, as it’s the last major data point ahead of next week’s FOMC decision. The Fed is in its pre-rate decision blackout, meaning that there won’t be any comment from officials to contextualize the data. With market expectations around interest rates shifting lately, the US Inflation figures could be pivotal to determine where the dollar goes over the next week.
Another important factor is that economists and analysts have been projecting inflation to rise and the economy to slow down due to tariffs. That’s also expected of the upcoming data. But it’s been a couple of months now in which those predictions haven’t been met out in the data. So, there is a decent chance of a surprise with Wednesday’s report.
Are We Looking at a Rate Hike?
Contrary to economists’ gloomy forecasts, US economic data has remained remarkably resilient and outperforming expectations. This latest was Friday’s jobs report. NFP came in at 139K, which was above expectations, but below the 12-month average. The unemployment rate stayed the same, and wages actually accelerated to the upside.
The wage issue is particularly important as more disposable income means more consumer demand and potentially higher prices. If economists are finally right and tariffs do increase inflation, there could be a double effect that could force the Fed to not only abandon rate cuts, but actually start hiking. However, the pass-through effect of import taxes on to consumer goods hasn’t been seen in the data, yet.
How Much Inflation Is There?
That tariffs are exacting a cost is clear in the data: Government tax receipts for the concept of import taxes are at record highs. But, it seems that the brunt of those costs are staying with businesses, who are hesitant to raise prices amidst a generally skittish demand. US consumer confidence has been relatively low over the last couple of months, also due to the tariffs. While this doesn’t mean the inflationary cost of the tariffs doesn’t exist, its impact could be further delayed and cause the upcoming data to surprise again to the downside.
US President Donald Trump has been repeatedly calling for the Fed to lower rates in order to support the economy. But activity in the US has been surprisingly resilient in the last couple of months. In fact, the Fed’s GDPNow tracker expects annualized Q2 GDP growth to jump to 3.8%. This heating up of the economy actually makes the case for the Fed to keep rates steady for even longer. With inflation already well above target, unless it starts to come down fairly quickly, the argument can even be made that interest rates need to go up.
What the Data Says
The consensus among analysts is that US May CPI change will accelerate to 2.5% from 2.3% prior. Higher food costs are seen as one of the major contributors to that increase. The core rate is expected to rise to 2.9% from 2.8% prior. This is well above the Fed’s 2.0% target rate.
But just because higher inflation might mean a more hawkish Fed, it doesn’t mean the dollar will gain. The greenback has been weakened by worries of the government’s debt situation. Higher interest rates would increase the cost to service the debt, and put the government’s financial situation under more pressure. That, in turn, could cause the dollar to weaken.