Last week, Fed Chair Jerome Powell surprised the markets a bit by insisting that the FOMC was not confident it had done enough to bring inflation down. This saw yields in US treasuries jumping higher and the dollar gaining strength.

Most of the major pairs for the greenback have shifted towards at least neutral if not waiting for an opportunity to ease. That leaves the Fed once again as the most aggressive of the major central banks, shoring up the value of the dollar. But, the conditionality in Powell’s speech – inflation coming down – puts much more weight on the coming data. If CPI change comes in with an important difference from expectations, it could shake up dollar pairs as investors recalibrate their expectations for the Fed.

Put a Fork In It

Despite what Powell said last Thursday, over 80% of Fed watchers believe that rate hikes are done. What the market has shifted to is focusing on when the Fed will start cutting. The consensus is that the third quarter’s blow-out GDP performance is a high-water mark. As growth is expected to slow in the coming months, the Fed will come under increasing pressure to bring rates down.

The question is whether inflation will be down far enough for the Fed to concede. That means the focus is now on how fast inflation is falling, and whether the trajectory matches current expectations. At the moment, money markets are pricing in the first Fed cut in the middle of next year.

How To Measure Expectations

If inflation falls faster than expected, then it would likely imply that CPI will be at a rate when the Fed can cut sooner. That could weaken the dollar, as yields would be expected to fall. On the other hand, if inflation remains stubborn, it could mean that the point of rate cuts will be seen as later. The dollar could gain some traction as yields would then be expected to remain higher.

All of this could be easily disrupted by the budget negotiations on Capitol Hill, where the most recent proposal from the House seems to have been shot down. With the deadline for averting a shutdown expected to be by Friday, the clock is fast running out to find a deal. A lack of an agreement could see yields rising, as investors price in higher risk for US debt.

What the Data Says

The consensus of expectations is that headline October CPI change will be at 3.3% annual, down substantially from the 3.7% reported in the previous month. This drop is being attributed to a reduction in the cost of energy, particularly petroleum-based products.

But where the real action is likely to be is around the core rate, which is expected to come down just slightly to 4.0% from 4.1% prior. This slow pace is what’s seen fueling expectations for the Fed to keep rates higher until the middle of next year. But, a beat of just two decimals would push the core rate higher, and that could shake up the markets as it might mean the Fed will actually go through with another hike. A miss would only support the growing narrative among traders that falling inflation means the Fed won’t hike, and it’s just a matter of how soon they cut.

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