After being whipsawed by the developments in the Middle East, markets could be relieved to deal with something relatively predictable: US inflation, normally the most important data release of the week. Consumer prices are top of mind for traders after what happened at the start of the week. The dollar his retreating while gold recovers, the two main Forex assets that could be affected by the data.
After the weekend in which Israel bombed Iranian fuel depots and Iran attacked oil refineries in the Gulf, crude prices skyrocketed, threatening to cause a tsunami of inflation. But on Monday, US President Donald Trump gave an interview in which he suggested that the war could be over soon. Originally, he said it could last up to four weeks, but now he implied it might be over as soon as next week. Despite the G7 failing to reach a deal on reserve releases, crude prices plummeted, wiping out all gains from the prior 24 hours.
Inflation Still a Concern
Now, Brent has fallen below $90 a barrel, which is still substantially higher than it was before the war. But it doesn’t have the same catastrophic potential, and worries of $150-200 crude have been allayed for now. Expectations that the ECB and the BOE will hike rates in the near term to fend off a surge in inflation have vanished.
The easing off on monetary policy concerns and a rebound in Asian stocks have allowed gold to recover. How long crude prices will remain elevated is anyone’s guess at this point, since there is no certainty about how long the war will last, and when transit through the Strait of Hormuz will resume. While there have been reports that the Strait is completely closed, vessel trackers suggest that at least some ships are crossing while shutting off their transponders, and turning them on again once they are through. It’s hard to quantify exactly how much crude is leaving, and what is possibly even more important, how much storage capacity is available in empty tankers in the Gulf.
Fed Bets Move Tighter
As a result, the market is still pricing in a more hawkish Fed. The odds of a July rate cut moved from 60-40 to about 50-50 on Monday. But the dollar weakened, as safe-haven flows unwound and the EURUSD recovered the 1.1600 handle. The dynamics of an ECB holding fast while the Fed continues to cut have reasserted themselves, and are likely looking to the upcoming data for confirmation. That is, unless there is another surprise development in the Middle East to throw things into disarray again.
First is the release of the US February CPI figures on Wednesday, with the consensus being for the trend of sticky prices to be maintained. Headline CPI is expected to remain unchanged at 2.4%, the same as in January. Similarly, the Core CPI is projected to remain unchanged at 2.5%. Both these readings are above the Fed’s 2.0% target rate.
The Market and Fed Reaction
Then on Friday is the release of the Fed’s preferred inflation indicator, the Core PCE price index. However, this is from January, delayed by the government shutdown last year. It is also expected to remain unchanged, but at 3.0%.
Last Friday’s dismal NFP figures were overshadowed by developments in the war in Iran, and the CPI figures could be an opportunity for the market to react. If inflation is cooler than expected, the market could price in an earlier rate cut and weaken the dollar. On the other hand, if inflation is higher than expected and everyone is sensitive to consumer prices, the dollar could gain on expectations that the Fed will hold off on rate hikes until the second half of the year.
