Fed rate hike inbound?

Preview: US core inflation ticking higher brings a Fed hike to the table; this week, Canadian CPI inflation kicks off a busy week of event risk.

US core inflation ticks higher

Last week wrapped up with the US August CPI inflation report hitting the wires. Ultimately, the YY and MM headline data were in line with economists’ expectations at 3.4% (unchanged) and 0.4% (up from 0.1%), respectively, while the YY core eased to 2.4% from 2.5%, with the MM ticking up to 0.3% from 0.2%. 

The MM core – bearing in mind we need approximately 0.16% MM to reach the annualised 2% target – is ‘probably’ sufficient to swing the pendulum towards a Fed rate hike on Wednesday, bringing the target rate to 3.75-4.00%, much to the chagrin of President Trump. You will recall that following the hotter-than-expected August US jobs report at the start of the month, Trump warned that if rates are not lowered, he would ‘stop trading with countries with which we have a deficit with’. It will be interesting to see what kind of reaction we get if the Fed defies him. At the very least, I expect a rather direct and punchy social media post.  

Interestingly, of the 93 desks polled by Reuters, 65 expect the Fed to remain on hold, while 28 believe a hike is on the table. Another divergence to consider is the gap between OIS and futures pricing. The former suggests a coin toss, while the latter is almost fully pricing in a rate hike (+22 bps).

Week ahead

Aside from the Fed rate decision, a busy data slate awaits this week, including August Canadian CPI inflation data today at 12:30 pm GMT, UK jobs (Tuesday), inflation (Wednesday), the BoE decision (Thursday), and a BoJ policy decision on Friday. 

Canadian CPI inflation on deck

For the Canadian print, economists expect the YY headline number to hold at 3% (max/min est. range between 3.2% and 3%), while the CPI median and trim measures – the BoC’s preferred inflation gauges – are expected to remain unchanged at 2% and 1.9%, respectively. 

Ahead of the event, it is worth noting that the market moved sharply hawkish across the curve in just a week (14 bps of tightening implied for this month’s meeting, up from 7 bps), largely on the back of Governor Tiff Macklem's commentary at the September meeting's press conference: ‘multiple rate increases could be needed if inflation proves problematic’. However, pass-through has been largely confined to gas prices and energy-intensive items such as airfares, without broadening into core categories.

I also think it is worth weighing this against the recent August jobs report, which landed earlier this month and added a fresh dovish counterweight. You may recall that employment fell by a little more than 40,000 (versus around +15,000 expected) – most of which were full-time jobs – along with wage growth decelerating sharply to 2% YY.

Consequently, I see this CPI report as a test of whether the recent repricing is justified. A confirming core print extends the recent hawkish pricing and bolsters the CAD. A miss, on the other hand, may pack more punch and trigger a sharper unwind. This is not only because it would feed into weak jobs data and build a considerably more convincing case for the BoC to hold in October, but also because of how much repricing has already happened into this release, and because the CAD is modestly overstretched to the upside.