Inflation is coming down, but not as fast as the Federal Reserve wants predict many analysts. On May 10 at 1:30pm GMT, we’ll receive an update on the Consumer Price Index for the month of April.
Foreign exchange markets have been treading water while markets weigh policymakers' rhetoric against traders conviction that U.S. interest rates, and the dollar, should fall.
What's the big deal?
Consumer Price Index (CPI) inflation is a measure of the average change in the prices of goods and services purchased by households in the United States over time. It is one of the most widely used measures of inflation, and it is closely watched by policymakers, investors, and the public as an indicator of the health of the economy.
Inflation can have both positive and negative effects on the economy. On the one hand, moderate inflation can indicate a growing economy and provide a stimulus for investment and job creation. On the other hand, high inflation can erode the value of people's savings and reduce their purchasing power, which can lead to a decrease in consumer spending and ultimately slow down economic growth.
In recent years, the U.S. economy has experienced low and relatively stable levels of CPI inflation. For example, in 2021, the CPI inflation rate averaged around 4.3%, which is higher than the average rate of the past decade but still relatively low historically. This moderate level of inflation has allowed the Federal Reserve to keep interest rates low, which has supported borrowing and investment and helped the economy recover from the COVID-19 pandemic.
However, there are concerns that inflation may accelerate in the coming years due to a combination of factors, including supply chain disruptions, labour shortages, and high government spending. If inflation were to rise significantly, it could have a negative impact on the economy and lead to higher interest rates, slower growth, and increased unemployment. Therefore, policymakers and economists are closely monitoring inflation trends and implementing measures to ensure the economy remains stable and healthy.
What's expected today?
Inflation nowcasts from the Cleveland Fed suggest a 0.5% month-on-month increase in core CPI for April, perhaps driven in part by rising energy costs during the month. That would disappoint the Fed, as it would hold annual inflation at over 5%.
Nowcasting refers to the practice of using recently published data to update key economic indicators that are published with a significant lag, such as real GDP.
The question remains as to when and if inflation will return to the Fed’s 2% target, and when the Fed may consider inflation sufficiently close to target levels that it is willing to ease back on interest rates. For now, the Fed appears set to hold rates at high levels for the remainder of 2023, based in part on the belief that inflation will remain stubbornly high. Though the bond markets aren’t convinced that the Fed will stay the course.
Currently markets expect the Fed to hold rates steady at that June meeting with a small chance the Fed elects to make another small hike in interest rates. That would likely only occur if inflation came in well above expectations.
Still the markets believe there’s a good chance that the Fed will be cutting rates by September and maybe even July. In order for that to happen we would likely need to see more data in upcoming releases that inflation is trending significantly lower, or some weakening of the U.S. economy, perhaps through the jobs market.
The upcoming CPI release may continue to reinforce the narrative that inflation is not falling as fast as many would hope.
What to trade?
If inflation shows signs of slowing more than the market has factored , expect big movement and fast.
if inflation shows signs of falling expect safe-haven currencies to lose out. Three major safe haven currencies are the US dollar (USD), the Japanese yen (JPY) and the Swiss franc (CHF). Mainly because the FED may start to reduce rates by the end of the year.
Gold and oil should receive a good positive bounce, for many reasons, especially it's good for the economy as a lagging indicator, if inflation is finally showing signs of abating.
Gold offers a volatile opportunity for traders as the data is released and digested by the markets.
Trading gold or oil?