US CPI and FOMC Meeting: High Volatility Day
Markets are getting set up for something like a rollercoaster tomorrow with some top rated events for the month happening practically on top of each other. US inflation figures for May are crucial for the market to figure out what to expect from the Fed’s meeting. But they will come out while the meeting is happening, and just a few hours before the decision is being made. That could lead to a one-two punch or boost to the markers, or a whipsaw effect, depending on how it goes. Futures markets are pricing in the most volatility ahead of an FOMC meeting since the end of the hiking cycle.
To make matters particularly dicy, the latest data figures from the US have left market expectations in a precarious spot. There was growing confidence in the outlook for rates as inflation figures seemed to be lining up to the downside again. Then last week’s surprisingly strong labor data came out, throwing the whole expectations game into the air. The inflation figures could have cleared that up a bit, but the market will have little to no time to react before having to deal with the fallout from the FOMC meeting, the statement, and finally Fed Chair Jerome Powell’s presser.
The Shifting Hopes and Fears
Just a week ago, the market had growing confidence that the Fed would start easing in September, and follow up with a second rate cut later in the year. That was after April inflation fell compared to the prior month, suggesting the trend towards the target had resumed. But after the Non Farm Payrolls data, the market now sees a September rate cut as practically a toss-up, and has largely given up on a second rate cut for the year.
Naturally this has helped propel the dollar. But now the question turns to the follow-through. And the upcoming CPI figures for May offer little to no respite. The annual headline inflation rate is expected to be unchanged at 3.4%, while the core rate (more closely tracked by the Fed) is also seen unchanged at 3.6%.
Getting Ready for the Shock
The expectations are setting up a situation where there could be a strong market reaction either way. Just one decimal beat in the core rate, and that means core inflation has started to rise. A two decimal beat in the headline would erase the last two months’ figures, and point to a rising inflation scenario. Should both happen at the same time, the market might become convinced that there will be no cutting this year. That could substantially boost the dollar and hurt equities. Especially considering that there is at least one FOMC member who has emphasized that rate hikes are not off the table.
Meanwhile a miss of one decimal point in either or both indicators could be a huge relief for the markets, indicating that inflation is still heading towards the target. That could erase the concerns that build up over the NFP data.
The Statement in Focus
Then comes the FOMC meeting, which is largely expected to leave things unchanged. The Fed has the July meeting, and the August Jackson Hole Symposium to telegraph a future rate cut if it were to go through with a cut at the earliest that the market expects. The statement could stick to the narrative that more information is needed to ensure inflation is going in the right direction. That’s what the market is currently pricing in – but, that’s assuming inflation comes in within expectations. If inflation falls and the Fed doesn’t acknowledge this, the statement could then be interpreted as hawkish.
This puts added weight on Powell’s post rate decision press conference, since he most definitely will be asked to comment on the latest inflation data. Depending on how dovish and hawkish he sounds, that could either maintain the market’s initial reaction or push it in a new direction.