All eyes are fixed on today’s August release of the US Consumer Price Index. Markets are expecting CPI prints in the next months to consolidate the return of inflation closer to the Federal Reserve's objective of 2%.
The CPI report out later today will provide the most recent indication of how far the Fed may need to go to get inflation back to its target. According to experts, monthly inflation is predicted to rise to 0.6% in August thanks to rising energy costs, while core inflation is expected to remain constant at 0.2%. Year-over-year, inflation is anticipated to grow to 3.60%, but core inflation is expected to fall by 4.3%.
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Figure 1: US CPI Data, Source: U.S. Bureau of Labor Statistics
If markets witness more sticky inflation higher than the 0.6% forecasted by experts, the bond market could start pricing in another rate hike before the end of the year, and possibly as early as November.
Markets are currently pricing in a 7% probability of a 25-basis point hike next week, with this jumping to 46% by November, according to Fed funds futures.
The recent substantial spike in the price of oil and several food products threatens to erode what has been a very beneficial and robust disinflationary drive from the goods sector up to this point. When this is combined with base effects becoming a headwind, the economy may see an increase in the frequently reported annual headline inflation statistic in the following months.
Although reported inflation has been improving for months, Federal Reserve authorities, including Governor Christopher Waller, are rightly concerned that the data could see a shift in direction.
Waller summarized the situation in an interview with CNBC as follows: “We’ve been burned twice before. In 2021, we saw it coming down and then it shot up. At the end of 2022, we saw it coming down, and that all got revised away. So, I want to be very careful about saying we’ve kind of done the job in inflation until we see a couple of months continuing along this trajectory before I say we’re done doing anything.”
If the inflation figures come in below market expectations, it could strengthen the case that the Fed will end its rate hike cycle in 2023, potentially depressing the US dollar. A sticky inflation print, on the other hand, might provide additional support to dollar bulls, as expectations of additional Fed rate hikes will likely gain more traction.
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