Tuesday’s release of US CPI data is particularly crucial because it’s the last time this series will be released before the next FOMC meeting on December 9th. Essentially, this is the data Fed officials will have when they sit down to discuss whether to raise rates, so it will likely define the market’s expectation for the rest of the month.
Markets are pricing in just under 80% odds of a rate hike at the next meeting, which is notable because it’s hardly changed from before Friday’s massive NFP beat. This suggests that the market is almost entirely focused on the inflation rate as a determinant for Fed policy. Taken in conjunction with the large drop in the markets last week, Tuesday’s data could be make-or-break for the dollar and gold, with market sentiment affecting other currencies as well.
What Really Matters With Inflation
Investors are heading into the data with unease. Although markets have attempted to stage a recovery, there is growing concern that higher rates combined with fiscal policy changes next year will snuff out the AI boom. As the market dropped, investors pared back bets the Fed would act, but then recovered after the strong jobs data.
Meanwhile, energy prices dropped dramatically after the election as investors bet that there would be less risk to supplies from the Middle East. However, the White House has provided contradictory signals on the subject, announcing new air strikes on Iranian territory while also conceding the election was in large part due to the war. In any case, crude prices are lower than a week ago, which helps reduce inflationary pressure. If energy prices decline substantially, there will be less concern about “second round” effects that would motivate the Fed to hike.
What the Market is Looking for
Two important inflationary data points will be released this week: CPI on Tuesday and PPI on Friday. If the first data point aligns with expectations, it might suggest that producer prices have a greater impact on the market. Traders are less worried about current inflation than about future trends that would keep the Fed hiking for longer.
The consensus is for US October headline CPI to heat up to 2.8% from 2.7% prior, but with less impact from energy prices. Crude rose in October ahead of the election, but it’s not expected to have translated into consumer prices quickly enough to generate a substantial change. The core rate, which is much more closely followed by the Fed, is projected to tick up to 2.7% from 2.6% prior. The tandem move suggests that the impact of energy prices is wearing off, but implies that long-term inflation might be settling in. The higher the core rate, the more pressure there would be on the Fed to hike.
How the Market Might React to the Data
Markets have been trimming back expectations for the Fed’s terminal rate. So, even though the odds of a December hike have remained almost unchanged, the market has taken a more dovish stance. That means there is a higher risk of a hawkish surprise, which could support the dollar, particularly amid a risk-off environment.
Friday’s PPI is projected to ease to 4.9% from 5.0% a month earlier. This implies that producers are facing higher prices than inflation, which could keep upward pressure on CPI. If inflation is lower and PPI is too, the market could substantially reprice a rate hike, weakening the dollar.
