There are two key data points that are shaping the behaviour of the dollar and gold this week. The first is on Wednesday, with the release of the minutes of the last FOMC meeting, which will provide insight into how the Fed will interpret the latest data trends. Then, on Friday, the US March CPI data is released, which is key to understanding the potential economic impact of the war in the Middle East.
At the last meeting, the Fed essentially punted, keeping policy unchanged as members awaited real data to see how the closure of the Strait of Hormuz would affect the economy. The main concern is, of course, a rise in inflation. But, depending on how long the war lasts, it could be fairly temporary. Between last week and this week, the Fed will get its most important data points that shape monetary policy: last Friday’s NFP report and the upcoming CPI report. Combined, this will give the market a much better view of what to expect from the Fed under the current circumstances.
What Are the Odds of a Rate Hike or Cut?
Ahead of the data, markets are pricing in an 80% chance that the Fed will hold policy unchanged between now and December. This is at odds with the FOMC’s assessment, updated at the last meeting, which expects one rate cut this year. The dissenters are evenly split between those calling for a hike and those calling for a cut.
This comes after a particularly strong NFP showing last Friday. The argument from FOMC doves has been that the jobs market is weak, so the Fed had to start cutting even before inflation came down to target. The incredibly weak February NFP validated that position. However, now that March has shown a strong shift back into positive territory, the dove’s argument is losing water. It could still be that March’s reading was an outlier, and February’s data could also be an outlier. But which position has more weight could come down to the focus placed on it in the minutes.
How Can the FOMC Minutes Move the Market?
The main market-moving issue from the upcoming FOMC minutes is how concerned the Fd is about inflation. Typically, the Fed focuses on core consumer price changes, excluding volatile food and energy components, to emphasise long-term price stability. While the war could momentarily push up energy prices, if it is resolved fairly quickly, the central bank might choose to “look through” the data and hold off on reacting unless there is a substantial increase in the core inflation rate. If that were the case, the dollar would remain strong, and gold could recover a bit, as it would mean a rate hike is not imminent.
On the other hand, if there is a preponderance of FOMC members in the minutes indicating they want to “get ahead” of inflationary pressures, this could mean the Fed might hike much sooner than the market currently thinks. This might help the dollar in the short term, but it will likely pull down gold.
What the Market is Looking For
The minutes provide important context for interpreting the upcoming CPI figures. If the Fed shows signs of being willing to ignore transitory bumps in headline inflation, then markets will likely focus on Core CPI. But if the Fed is particularly concerned about inflation bleeding over into the rest of the economy, the market could react more to the headline rate.
The consensus among analysts is that the US March headline CPI will jump to 3.1% from 2.4% in February. This is moving well away from the Fed’ 2.0% target. However, the bulk of the gains are expected to be attributed to a jump in gasoline and diesel prices due to the war. The core rate is anticipated to tick higher to 2.6% from 2.5% prior, as it will take time for higher energy costs to filter through to the broader economy.
