Will the Fed Pivot? Key Inflation Data Could Decide Rate Cut Path

Key Takeaways

• The U.S. will be releasing a critical inflation report this Thursday.
• Irrespective of the outcome, traders should prepare for above-normal volatility.
• The market bet that the report will confirm the Fed's latest assessment that the U.S. inflation is slowing.
• A higher-than-expected CPI figure will disproportionately impact the market because investors widely expect the Fed to cut its base rate in September.

This Thursday, the U.S. Bureau of Labor Statistics (BLS) will publish the Consumer Price Index (CPI) report at 12:30 p.m. UTC. The CPI report will clarify the inflation pace in the U.S. Specifically, the data will show how the prices of goods and services purchased by consumers changed over the past month. Most investors and traders will focus on the core inflation rate, which tracks the changes in prices for a basket of goods, excluding food and fuel.

The importance of the upcoming CPI report is to be considered. It is traditionally one of the most impactful events in the financial markets because of its direct influence on the Federal Reserve’s (Fed) monetary policy decisions. Because the report can potentially change investors' interest rate expectations, it will likely spur above-normal volatility in all financial instruments - including Forex pairs and metals. A surprisingly strong report or an unexpectedly weak one may trigger sharp moves - particularly in the U.S. Dollar Index (DXY), U.S. Treasury yields and stock indices.

According to Reuters, the market expects a 0.2% rise in monthly core inflation and a 3.4% annual increase. Generally, inflation has been slowing down lately, and the market expects this trend to continue. Indeed, the Fed Chair, Jerome Powell, said last week that the U.S. was on the ‘disinflationary path’. However, he also stressed that policymakers need more data before cutting interest rates to help determine if the recent slowdown in inflation represents a real, long-lasting trend.

‘Powell is trying to strike a delicate balance. I think he understands that the market wants him to be dovish, but he is not ready to fully commit to a rate cut yet’, said Kar Yong Ang, Octa analyst. Indeed, after a string of disappointing U.S. macroeconomic reports, investors have increased their bets on the Fed rate cut in September, with the probability of a 25-basis point (bps) reduction currently standing at around 74%. Furthermore, interest rate swaps market data implies more than 50 bps worth of cuts by the end of 2024. Unsurprisingly, DXY, which measures the U.S. dollar's (USD) value against a basket of currencies, has been falling lately. ‘There is currently too much faith in a September rate cut. Should the CPI figures come out higher-than-expected, DXY will skyrocket, pushing gold price down’, said Kar Yong Ang, Octa analyst. By the same token, a softer-than-expected report will exert additional bearish pressure on the U.S. dollar, pulling gold prices higher. However, because the dovish Fed scenario is already priced in, gold prices may struggle to rise much above $2,420 per ounce.