Inflation Swing: CPI Release and Implications for FOMC Decision
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FX Daily: Jumping on the inflation swing
Today’s CPI release in the US is arguably the biggest risk event of the week. This is because it can tilt the balance ahead of a 'toss-up' FOMC announcement tomorrow, and because anything ECB related may well play second fiddle to moves in USD rates. A 0.4% MoM core consensus read should, in our view, allow the Fed to stay on hold, but may not hit the dollar just yet.
USD: Small deviations in core inflation can have huge implications
The currency and rates markets approached this week with a very elevated beta to data releases as markets remained on the lookout for hints on the activity and employment outlook ahead of the Fed’s policy announcement tomorrow. Inflation, however, remains the single most important input in the FOMC’s decision-making equation, and today’s CPI numbers for May likely have a make-or-break potential for a 25bp hike tomorrow, which is currently priced in with a 23% implied probability.
The median consensus estimate for the month-on-month core CPI read – which will effectively move markets – is 0.4%, with estimates ranging from 0.3% to 0.5%. A 0.4% MoM print (translating into a 5.2% core year-on-year rate) is also our economics team's call, and one that would in our view allow the majority of FOMC members to favour a hawkish hold over a 25bp hike tomorrow. It would probably take a 0.3% read to price out the residual 23% implied probability of a hike tomorrow, meaning that the dollar does not need to fall much on a consensus print today.
The spectrum of market reaction is much wider in the event of a 0.5% MoM core inflation read. We think the odds would likely swing in favour of a hike tomorrow, and markets could push their implied probability above 50%, sending the dollar higher across the board. The most visible consequence in G10 FX would probably be another jump in USD/JPY (ultra-sensitive to Fed pricing) and a potential break above the 140.90 end-of-May recent highs.
In terms of the headline measure, the consensus is expecting a month-on-month 0.1% change, translating into a slowdown from 4.9% to 4.1% YoY. But it will almost entirely be up to the core rate to drive the market reaction.
