US Inflation Preview: Why the US Dollar is more likely to fall than rise, three scenarios


  • Economists expect US underlying inflation to have risen by 0.4% MoM in May.
  • A minor downside surprise one day before the Federal Reserve decision would down the US Dollar.  
  • Gains for the Greenback look limited in response to an upside surprise due to the proximity of the Fed’s meeting.

Nerve-wracking does not begin to describe it – the No.1 economic indicator is released only one day before the most potent market mover says its word, and volatility is set to explode. Consumer Price Index (CPI) data is released at the same time as  Federal Reserve members are convening to discuss their interest-rate decision, and they will be watching it closely. For traders, there are three clear scenarios – and not all are equal.

Here is a preview of the CPI data for May, due out on Tuesday at 12:30 GMT.

Why US CPI is important, and its recent developments

The Federal Reserve has a dual mandate – full employment and price stability. With the labor market looking healthy, the central bank focuses on inflation, which raised its ugly head after years of being tamed. CPI releases have triggered more volatility than Nonfarm Payrolls publications in the past year.

The good news is that headline inflation is falling – CPI stood at 4.9% YoY in April, nearly half the peak of 9.1% recorded in June 2022. Falling energy prices and unsnarling supply-chain issues led to the decline. 

Source: FXStreet

Economists expect another sharp fall in the CPI YoY in May, down to 4.1%. However, that is not what investors and the Fed focus on.

The world's most powerful central bank wants to see Core CPI – which excludes volatile food and energy prices – fall toward the prized 2% area. A bustling labor market means higher wages and, thus elevated "sticky" inflation. This measure of underlying inflation stood at a stubbornly high 5.5% in April, and economists forecast only a small retreat to 5.3%.

Is Core CPI moderating? That is best measured by the monthly figure, which is chopping its way down but refuses to provide enough relief. It rose by 0.4% in April, an annualized pace of 5%, uncomfortably high. A repeat of that figure is on the cards for May.  

Source: FXStreet

This time, CPI data is published as Federal Reserve officials convene in Washington for their two-day rate-setting meeting. Fed Chair Jerome Powell and his most influential colleagues have signaled the Fed will leave rates unchanged – the first such move in over a year, and as rates have topped 5%, roughly matching core inflation. 

Nevertheless, Fed officials left the door wide open to additional tightening in July, leaving investors on edge. According to bond markets, there is a 68% chance of a hike in July and a 26% probability of an increase already this week.. 

Source: CME FedWatch Tool

This high uncertainty implies more volatility, but it also tells about the potential reaction. 

Three Scenarios for Core CPI and the US Dollar

1) As expected: If Core CPI hits estimates with 0.4% MoM, the US Dollar will likely decline. Why? While a 0.4% is elevated, such an outcome would be insufficient for the Fed to raise rates imminently. The bank refrains from surprising markets, and a 0.4% rise in May does not guarantee a hike in late July – more data still awaits investors until then. 

As bond markets still price more than a one in four chance of a rate increase, this outcome might deflate these probabilities and push the US Dollar down. 

I see this scenario as having the highest probability, as economists' predictions were accurate in the past four out of five releases. 

2) Below expectations: An outcome of 0.3% or below would take the wind out of hawks' sails, fully closing the door on a rate hike. It would also diminish the chances of a rate increase in July. The reaction would be a party in stock markets and a tumbling down of the US Dollar. 

With more signs of weakness in the US economy – such as the recent jump in jobless claims – I give a 0.3% rise a medium probability. Anything lower than that seems unlikely and would trigger even wilder moves.  

3) Above expectations: A 0.5% increase in Core CPI would reflect an annualized level of 6%, above the current YoY figure – a massive disappointment. The US Dollar would soar on speculation of a last-minute change at the Fed, and stocks would crash. 

I see 0.5% as possible, but having a low probability. Any leap in the Greenback would likely be reversed – the Fed is unlikely to shock markets unless it is shocked. For a rapid change of heart, a 0.6% Core CPI increase seems to be the minimum. 

Nevertheless, a 0.5% rise would substantially lift the chances of a hawkish stance by Fed Chair Jerome Powell on Wednesday and the probability of a rate hike in July. Once again, I see this scenario as the least likely of the three.

Final thoughts

The Fed is focused on inflation, and CPI provides hard evidence of how price rises are developing. Coming one day ahead of the Fed decision – and as members are prohibited from speaking to the media – tensions are high and volatility will likely be elevated. 

I lean toward lower rather than higher inflation, as well as a weaker US Dollar. Still, I suggest trading with care in these nervous markets.

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