US inflation needs to be really bad to stop the USD

  • US Core Inflation is expected to recover after a blip in August.
  • Fed expectations for a hike in December are set to strengthen.
  • Barring a second consecutive disappointment, the USD will likely remain bid.

The US publishes its Consumer Price Index report for September on Thursday, October 11th, at 12:30 GMT. The Fed has two mandates: employment and price stability. The CPI report provides a fresh update on inflation, thus impacting the Fed and the US Dollar.

Expectations: Showing that the slowdown was a one-off

The job market continues creating jobs at a healthy pace while core inflation is well-anchored around the 2% target. The Fed cares about core prices: the changes that do include energy and food, which are quite volatile. Will we see signs of inflationary pressure now?

The Fed target the Core PCE which stood at 2% YoY in August. The Core CPI had a different methodology and stood at 2.2% in August. We will now get the fresh Core CPI for September.

Back in August, core inflation decelerated to 2.2% from a cycle high of 2.4% in July. This time, an increase to 2.3% YoY is on the cards. Month over month, an increase of 0.2% is projected after 0.1% in August. All in all, expectations are for a return to normality, data that will show that August was a one-off and that price development is not slowing down.

Headline inflation carries expectations for a rise of 2.8% YoY after 2.7% beforehand, and 0.2% MoM, a repeat of last month’s increase.

Potential USD reaction

The US Dollar enjoys the back wind of robust growth in the US economy, a hawkish Federal Reserve and high bond-yields. Also, the trade war that Trump is waging with China props up the greenback which receives demand as a safe haven currency.

Therefore, if the data meets expectations, the greenback could move up. An OK figure is more than good enough. According to bond markets, there is a 3 in 4 chance for a rate hike in December, the fourth one in 2018. An OK number will be good enough for the greenback.

Any acceleration will likely give the greenback a more significant boost, especially if the cycle high of 2.4% YoY is broken. That may not only strength expectations for December but also push the projections for 2019 a bit higher.

If Core CPI remains stuck at 2.2%, it would be a disappointment but not a disaster. The US Dollar will likely drop in the immediate aftermath but probably recover. It does not fundamentally change the picture.

A drop to 2.1% would already mean a second consecutive month of decelerating inflation, and that would serve as a warning sign. Expectations for a rate increase in December will likely remain high, above 50% but the greenback may suffer a more meaningful drop.

Conclusion

The US CPI report is a top-tier publication and critical for the Fed’s rate decision. A small acceleration is on the cards, and it would show that August’s dip was a one-off. The US Dollar is well-positioned into the event, and only a significant miss could inflict severe damage to the current uptrend.


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