US CPI Preview: Will Inflation Tip the Scales on a Fed Rate Hike Next Month?

US CPI KEY TAKEAWAYS:

• US CPI expectations: 3.4% y/y headline inflation, 2.5% y/y core inflation
• Traders are lacking clarity on what the FOMC will do next month, with markets pricing in 50/50 odds of a rate hike.
• The US Dollar Index is showing signs of forming a meaningful near-term bottom, especially if the CPI report tips the scales toward a September rate hike.

When is the US CPI report?

The US CPI report for July will be released at 8:30ET (12:30 GMT) on Wednesday, August 12.

What are the US CPI Report Expectations?

Traders and economists are projecting headline CPI at +0.1% m/m (3.4% y/y) and Core CPI at +0.2% m/m (2.5% y/y).

US CPI Forecast

You know that nervous feeling when you’re about to get your grade on the test you turned in two weeks ago? FOMC Chairman Kevin Warsh may be feeling a bit of that ahead of the US CPI report.

While he talked a tough game about price pressures, vowing to deliver 2% inflation, three of his FOMC colleagues outright dissented against the majority, arguing an immediate interest rate hike was needed to fend off inflation (see four other reasons Warsh’s “honeymoon at the Fed is over here). This week’s CPI report will be the first indication of which side of the FOMC was more in tune with the current economy.

As the chart below shows, Fed Funds Futures markets are currently pricing in almost exactly a 50% chance that the central bank will raise interest rates at its meeting next month after last week’s weaker-than-anticipated NFP report:

Source: CME FedWatch

Clearly, traders are lacking clarity on what the US central bank will do next month, and Warsh’s preference for less communication from the central bank is certainly playing a role. As the WSJ’s “Fed Whisperer” Nick Timiraos noted, “A firm [CPI report] could force [Warsh] to demonstrate with action what he struggled last month to convey in words.”

However, readers should note that the Fed will still get another CPI report (as well as another NFP reading) before the next FOMC meeting on September 16^th, so this report alone won’t fully tip the scales on the Fed’s decision.

As many readers know, the Fed technically focuses on a different measure of inflation, Core PCE, when setting its policy, but for traders, the CPI report is at least as significant because it’s released weeks earlier. As we noted above, has remained stubbornly above the Fed’s 2% target for a half-decade already, and leading indicators are suggesting it could rise further from here:

 

Source: TradingView, StoneX

Looking at the chart above, the “Prices” components of the PMI reports held steady last month, but may still point to a higher headline inflation reading if the historical correlation holds. A hot reading would put Warsh in the proverbial hot seat to deliver a rate hike in September, whereas a benign print would buy time (including ahead of his keynote address at the Jackson Hole Economic Symposium at the end of the month).

Either way, the stakes are high heading into this month’s CPI report, so traders should be prepared for volatility.

US Dollar Index Technical Analysis – DXY Daily Chart

Source: TradingView, StoneX

Turning our attention to the world’s reserve currency, the US Dollar Index (DXY) is showing early signs of a potential bottom after the late July swoon. The index has now found support twice at the 99.40 level in August, forming a bullish divergence with the 14-period RSI in the process. This setup shows fading bearish momentum and could hint at a more meaningful bottom forming if the CPI report comes in hotter than anticipated.

Meanwhile, a soft reading would weigh on the greenback, with a break below 99.40 potentially exposing the 61.8% Fibonacci retracement at 99.20 and the 99.00 in short order.

-- Written by Matt Weller, Global Head of Research

Check out Matt’s Daily Market Update videos on YouTube and be sure to follow Matt on Twitter: @MWellerFX