Unfulfilled expectations? – Commerzbank

After last week’s focus was on the state of the US labor market, inflation is back on center stage this week. The US Dollar (USD) already showed some weakness yesterday when the Producer Price Index (PPI) was released, which came in slightly below analysts’ expectations. This was partly due to the fact that some components of the PPI are directly included in the calculation of the inflation deflator. PCEwhich is the Fed’s preferred measure of inflation. But the lower-than-expected PPI likely also fueled hopes that today’s consumer price data could be lower than expected, notes Commerzbank FX strategist Volkmar Baur.

The risk is more in the direction of a stronger USD

“When this happened last month, it triggered significant market moves. On July 10, the day before the latest CPI release, EUR/USD was at 1.08. At the same time, the two-year Treasury yield was more than 40 basis points higher, and the market was expecting two 25 basis point rate cuts by the Fed by the end of the year, not four.”

“The risk is probably more in the direction of a stronger USD. The Fed will not consider cutting rates more quickly and aggressively just because inflation is moving faster towards 2%. The current annual rate of around 3% is still too high, even if monthly rates have been low recently. But, if inflation turns out to be higher than expected, contrary to today’s hopes, this would make a 50 basis point move in September unlikely.”

“Our economists have recently reiterated that they do not expect a US recession in the near term. In that case, I think it is highly unlikely that the Fed will move by 50 basis points at one of the three remaining Fed meetings, which is what the market is currently pricing in. And in all likelihood, this unpricing will not be gradual, but tied to a data point. It may not happen today, but it very well could happen at some point over the next few weeks.”