The major data event this week for the markets is likely to be Tuesday’s release of US CPI figures. That’s because the outlook for the Fed’s rate policy is starting to shift. As a result, the dollar has resumed its fall, affecting most of the major currency pairs. If the data comes out significantly different from what is expected, it could have a major impact on the markets.
The impact might go beyond the immediate data release. Depending on how inflation evolves, its interpretation by key market players could have a significant effect, as well. As the days count down to the expected rate cut, what Fed officials say in response to the inflation data could be pivotal.
The State of Play: Why No Rate Cuts
At the last meeting, the FOMC once again and controversially decided to keep rates unchanged. The main argument given was that inflation might rise as a result of tariffs. The Fed needed time to see what the impact would be. Besides, the economy was solid, so there was room to keep rates in restrictive territory for a while longer. High interest rates typically slow down economic growth.
Just two days later, dismal labour figures suggested the US economy wasn’t doing as well as the Fed thought it was. This convinced most of the market that a rate cut was coming. After all, the FOMC itself had even said that it expected two rate cuts in the second half of the year. And there are now only three more meetings left for 2025, so time is running out.
The Odds of a Cut Are Shifting
Last week, the market priced in the chance of a rate cut as high as 90%, but those odds have started to diminish. Two more FOMC officials last week said they were partial to cutting rates “soon”, suggesting there was building momentum for easing. But it’s still a long time until the next meeting. The Fed normally takes a hiatus in August, so we will get another crop of labour and inflation data before the next meeting. That could once again shift perception on what to expect from the Fed.
If inflation were to come in above expectations, then that could make the case for rates to remain unchanged past September. Normally, that would be expected to support the dollar. But it will likely mean that traders worry that the US will see slow growth, if not an outright recession. As a result, investors could resume selling dollar-denominated assets, causing the greenback to weaken.
What to Look Out For
On the other hand, weaker inflation might also drag on the dollar. If inflation is understood to be declining because the US economy is slowing down, then the Fed will be more likely to cut. That would also likely weaken the dollar. On the other hand, if inflation is primarily the result of tariffs and not weakening consumer demand, then the dollar might not weaken so much.
The consensus is for US July headline CPI to rise to an annual rate of 2.8% from 2.7% prior. However, the Fed pays closer attention to the core rate, which strips out more volatile elements such as food and energy (both of which are subject to tariffs). Core July CPI change is expected to accelerate to 3.0% from 2.9% prior.