The key event of the day is the highly anticipated inflation data for May which will be released by the US Bureau of Labour Statistics (BLS) at 12:30 GMT. Leading up to the Consumer Price Index (CPI), the USD has fluctuated after the release of disappointing economic data, particularly due to a mixed May Nonfarm Payrolls report.
The series of weak data has increased expectations that the US Federal Reserve (Fed) will pause its interest rate hike during its two-day policy meeting this Wednesday. According to the FedWatch Tool, there is a 76% possibility of an impasse at the FOMC event on Wednesday, while markets still expect a 25 bps rate hike at the Fed’s next meeting on the 26th of July.
How will the inflation data affect the Fed’s decision?
The US CPI inflation data has the potential to influence the Fed’s decision and it could determine whether the central bank will align with market expectations and put a stop to its tightening cycle. Consequently, the US dollar will be influenced.
CPI data report
Investors anticipate the US CPI to increase by 4.2% on a yearly basis in May, and the Core CPI is expected to rise by 5.6%. For the monthly CPI, investors expect a 0.3% increase in May, but the Core CPI is expected to remain at 0.4%.
According to Fed Chairman Jerome Powell’s comments at the Fed’s Thomas Laubach Research Conference last month, inflation will take some time to moderate, and the central bank would closely monitor data as it decides whether to raise rates in the coming month.
The central bank is widely expected to refrain from raising rates at this meeting and potentially choose to tighten policy at a later date. Disappointing data such as the US ISM Services PMI and weekly Initial Jobless Claims have raised concerns about the economy. With expectations of further cooling of US inflationary pressures, the probability of a Fed pause this week is quite high.
How will the market react after CPI data is released?
If inflation data, particularly the monthly core inflation, falls below expectations, it could challenge the market’s belief that the Federal Reserve might resume tightening later in the year after skipping it in the June meeting.
Following last week’s mixed NFP and wage inflation data, investors are seeking further guidance on the Fed’s interest rate outlook.
If inflation data turns out to be softer than expected, it will reinforce the market’s expectation of a dovish Fed, contributing to the current decline in the greenback. If the US reports surprisingly high inflation figures, it could boost the US dollar and revive expectations of Fed rate hikes. Regardless of the outcome, the US CPI data is expected to generate significant volatility in the US dollar.
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