Tuesday sees the release of what is likely to be the most important data this week, as markets try to figure out what the Fed will do under new management. Inflation is now the key focus for markets after April NFP significantly reduced the justification for easing. Gold prices as well as the dollar could react substantially if there is a major surprise in the figures.
Last year, and through the first couple of months of this year, doves on the FOMC have made the case that a weak labour market justifies cutting rates. Inflation has been above the Fed’s target for more than four years now, but the Fed has managed to lower rates, citing the jobs market. However, after Friday’s data, that justification might be losing its weight, which puts inflation front and centre as the key metric for the Fed.
The Market Reacts to Improving US Labour Market
April’s NFP was the second consecutive month in which US job creation was in triple digits and well above analysts’ expectations. Although not yet back to growth levels, the results indicate that the strong March reading wasn’t an outlier. In fact, the jobs market might have bottomed out around the start of the year and is starting to rise.
One of the issues that the Fed had to deal with last year was the expectation that tariffs would raise inflation. However, the rise was well below economists’ expectations, allowing the Fed to resume rate cuts in the final quarter of the year. That could be explained by a weak jobs market that kept consumer sentiment depressed. If employees are worried about income security, they can reduce spending and avoid buying items that have price increases. This blunts the effect of price hikes.
Jobs Recovery Can Pressure Inflation
On the other hand, if consumers are optimistic about the job market, they could be more willing to spend. This increases consumer demand and allows price hikes to materialise. If there are underlying price pressures, for example, from higher energy costs coupled with consumers willing to spend more as hiring picks up, this can push inflation higher.
So far, markets are unsure about this outcome and are still pricing in around 70% odds that the Fed will keep rates unchanged. But the 30% dissenters have switched from calling for a cut to calling for a hike. This has left the dollar stronger and gold generally weaker. Whether this trend continues will likely depend on US inflation pressures remaining apparent.
What the Market is Looking For
The consensus expectations are that the headline US CPI for April will jump to 3.7% from 3.3% in the previous month. However, the main focus is whether these higher prices are bleeding through to the broader economy and pressuring medium-term inflation. That is better seen when energy and food prices are stripped from the reading. Core US April CPI is expected to tick up to 2.7% from 2.6% previously.
If inflation comes in hotter than expected, the market is likely to see a higher chance of a Fed rate hike this year, which could support the dollar at the expense of weaker gold. Particularly if core inflation is rising faster than expected. On the other hand, softer inflation data could indicate that the Fed will be able to hold out longer and might even cut rates later in the year if the energy situation normalises. That could weigh on the dollar, but support gold.
