What to expect from US Inflation data on Thursday

The latest Fed minutes sum up the conundrum for the market nicely when it comes to understanding what the approach to the USD and Fed policy is. The Fed minutes show that no Fed participants see a rate cut appropriate for 2023. However, Fed fund futures expected 2 rate cuts at the start of the year.  So, the market is fighting the Fed on the way down. The general rule of thumb is ‘never fight the Fed’. 

Last week saw some very good labour data. Lay offs felll from over 75k down to -45K, ADP employment rise to 235K vs an expected 150k. Moreover, initial jobless claims were lower to 204K with the prior revised lower too. Firm NFP data on Friday means that, with a very strong labour market, the Fed will feel the need to do more – or at least to maintain their hawkish stance which they revealed in the Dec minutes, aka, ‘no cuts for 2023’. However, friday’s US ISM Services PMI print has investors speculating that this shows growth slowing and the Fed may cut rates this year after all. One data point hints that way, the next the other way.

So, now US inflation data takes the plate after Powell was pretty much silent on US monetary policy on Tuesday’s anticipated speech. The Fed has taken some gentle encouragement from the last two falls in CPI, so a big surprise to the upside here will worry the Fed and make them dig into the ‘no rate cute in 2023’ narrative.

US inflation focus

The current expectations as of January 12 are for core inflation to fall to 5.7% from 6% prior. Headline inflation is expected to drop as well to 6.5% from 7.1% prior. Will this be the third consecutive drop for US inflation or will there be a surprise. The way the market will react to this data point is most likely to be as follows. A strong inflation reading that comes in above 7% for the headline and above 6 % for the core will show market participants that the Fed still has more to do in terms of hiking rates. If we get a big surprise Thursday, with inflation surging higher, then expect USD strength and EURUSD weakness. So, this is what to look for:

Headline y/y rate 7% or higher and core above 6% then expect: EURUSD selling and S&P500 selling

In terms of the bigger picture it could send the USD moving higher again if investors think the market will need to price out those two rate cuts it is expecting. If so, then expect another leg lower in equities too. Scalping EURUSD lower on a strong beat looks like the best option for short term trades with markets selling the USD since last Friday’s services PMI miss. Medium and longer term traders should watch this space, but a deep fall for gold and silver offer’s value depending on the incoming data going forward of course. One high inflation print won’t totally change the narrative, but it will cause a pause in some of the recent USD weakness.