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US Inflation Cheat Sheet: Five scenarios for Core CPI and the Dollar's explosive reaction

  • US inflation has proved the #1 market mover in recent months. 
  • Every tenth in US Core CPI makes a difference as markets await the Fed. 
  • Ranges between 0.2% to 0.6% are plausible each means something else for the Dollar. 

"King of forex indicators" is how the Nonfarm Payrolls report was called, but that belongs to the past. In 2022, rising inflation has meant that the Consumer Price Index (CPI) report has the most significant impact. 

The last release in 2022 is due out just one day before the Federal Reserve announces its decision and also publishes new forecasts. Fed Chair Jerome Powell is set to oversee a 50 bps rate hike – lower than 75 bps, but alongside a promise to continue hiking next year. 

An extreme outcome can change the rate decision, and even a small deviation could impact Fed members' forecasts. The bank's focus is on Core CPI – price rises excluding energy and food. The monthly figure stood at 0.3% last time, causing markets to cheer after two miserable rises of 0.6% in the previous two months.

This time, the economic calendar points to a rise of 0.3%. That may or may not be too optimistic and is one of five scenarios.

1) Positive surprise, 0.2%

If underlying inflation not only remains low but decelerates, the US Dollar would tumble and stocks would cheer. It would imply an annualized rate of 2.5%, something the Fed and Americans would love to see. 

The reason for such a drop would be the unsnarling of supply chain issues, which have been driving up the prices of goods. However, this scenario seems highly unlikely given the overall health of the US economy. 

In such a case, Fed officials might be open to ending the rate hike cycle as soon as February, but once again, chances are low.

2) As expected, 0.3%

A repeat of October's low figure would prove that it was not a one-off, and that inflation is genuinely slowing down. It would keep the option of a 50 bps hike in February open, but would still cheer markets and send the Dollar down. After an initial decline, the Greenback would stabilize.

I see a medium probability of this scenario, given economists' expectations, which seem too optimistic to me. The increases in services prices look sticky, insufficient for another month of annualized inflation at under 4%. That will probably take more time. 

3) Small beat, 0.4%

While such an outcome would ostensibly be Dollar positive, I see it as neutral. Using annualized numbers once again, it would reflect an increase of roughly 5.0%, which is significantly below the current YoY level of 6.3% and still proof that last month's 0.3% was not a one-off. 

On the other hand, it would show that the war against inflation has a few more battles in store, and that the Fed would hike by 50 bps in February before potentially stopping. 

In this scenario, the Dollar would initially bounce on the beat before selling on the decline in comparison to the previous month. I give this outcome a high probability. 

4) Bigger beat, 0.5%

While this would be one-tenth below the stubborn 0.6% reads for August and September, such an outcome would reflect a sticky annualized underlying inflation level of nearly 6%. That is bad news for Americans and for markets. 

It would also be a significant beat of expectations, boosting the Dollar and keeping it elevated ahead of the Fed. The bank would then signal a near-certain 50 bps increase for February and probably point to ending 2023 with a rate above 5%. 

I give this scenario a medium probability. 

5) Back to the drawing board, 0.6%:

A return to those nasty jumps – reflecting an increase of 7.2% annualized – cannot be ruled out. I see it as having a low probability but above the chances of a 0.2% increase. Why?

Americans keep on buying goods and also consume services and experiences. There is still too much excessive cash in shoppers' pockets, and the drop in gasoline prices leaves more free cash to spend on other things. 

In such a scenario, the Dollar would jump and then continue rising, settling only close to the Fed decision. Some would speculate about another 75 bps hike – highly unlikely, but Fed Chair Jerome Powell could signal two more 50 bps hikes in early 2023. Markets would be devastated. 

Final thoughts

November's CPI report comes at a sensitive time and that adds to the complexity. Every tenth matters not only for the initial reaction but also for the positioning ahead of the Fed.

Author

Yohay Elam

Yohay Elam

FXStreet

Yohay is in Forex since 2008 when he founded Forex Crunch, a blog crafted in his free time that turned into a fully-fledged currency website later sold to Finixio.

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