US CPI: What’s the trade today?

Expectations going into the US CPI print today is for headline inflation to rise to 7.0% year on year. The core reading is 5.4% y/y and the polled economists still project that the US has not reached peak inflation. The Fed, like central banks around the world, are becoming increasingly concerned with inflation and this has been driving their most recent acceleration towards hiking rates. At their last meeting, the Fed is now projecting three interest rate hikes for this year. Fed fund futures are projecting three interest rate hikes and Goldman Sachs see a case for four interest rate hikes.

What does that mean for markets?

Well, as long as earnings continue to move higher then markets can absorb the moves higher in interest rates. However, if growth is slowing, but the Fed is hiking then we could see a sharp correction in stocks like we saw in the fourth quarter of 2018. This is what has been behind the recent fall in stocks to start the year.

In this context the CPI print is important as any relief in inflation levels will see expectations drop about the need for the Fed to hike interest rates so rapidly. At the moment QE is expected to end by March, the first interest rate hike is expected to take place then, and the balance sheet runoff can happen as soon as rates lift-off.

The trigger

If the core y/y reading comes in below 5.3% then that should weaken the USD. Remember the key metric for the Fed is the core reading rather than the headline reading which is expected to come in at 7.0%. A good pair to consider in the event of the CPI print disappointing would be a EURUSD, GBPUSD long or an NZDUSD long at market from a disappointing print. This should weaken the USD and lift these pairs.

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