US inflation preview: A small change in CPI can trigger a big move for USD and the Fed

The US releases its Consumer Price Index report on Tuesday, June 12th, at 12:30 GMT.

Why this inflation report is more important

While the Federal Reserve prefers the PCE over the CPI, the latest PCE is for April while the upcoming CPI report is for May, providing fresh insights. 

The inflation data is published as the Federal Open Markets Committee (FOMC) convenes to makes its rate decision. The Fed signaled it will raise rates and that will be no surprise. Nevertheless, the tone of the statement and the following changes in interest rates are unknown to markets.

The US enjoyed strong and steady growth in employment in the past few years. According to the economic textbooks, an economy at or near full employment should have generated prices pressures. This has not happened yet and remains a mystery. Rising inflation is needed for the Fed to accelerate the path of rate hikes.

Therefore, stronger inflation figures can tilt the Fed towards a more hawkish statement. Yet if Fed Chair Jerome Powell and his colleagues see more modest changes in prices, they may opt for more cautious wording. The critical input from the CPI report can, therefore, have a considerable impact on the US Dollar.

What to expect

The most important figure is Core CPI YoY. In the report for April, it stood at 2.1%, falling short of expectations to accelerate to 2.2%. The same expectations await us now: 2.2% YoY and 0.2% MoM, which would be faster than the disappointing 0.1% increase seen in April.

Headline CPI is also expected to rise, from 2.5% to 2.8% YoY accompanied by an increase of 0.2% MoM, repeating the increase seen in April. Rising fuel prices drive headline inflation higher and will be ignored by the Fed, which focuses on core prices.

The Core PCE stood at 1.8% YoY in April, lagging by 0.3% behind the Core CPI. The Fed's target is 2% Core PCE. So, if the Core CPI jumps to 2.3%, it would imply that the Core PCE reaches the elusive 2% target and that would provide an even stronger boost to the US Dollar. 

If the Core CPI stays put at 2.1% for a third consecutive month, or even drops back, it would be a disappointment and would also leave the Fed puzzled about what to do next.

USD positioning

The US Dollar suffered a correction after long weeks of gains. It seemed to have paid its dues and is not stretched anymore and may be set for further gains. 

Moreover, the recent clashes around trade between US President Donald Trump could boost the greenback against all currencies except the safe-haven Japanese Yen. Higher tariffs and growing tensions could reduce global trade and deal a blow to global growth. The consequent demand for safe haven currencies has not fully materialized.

Higher inflation means further rate increases and additional pressure on emerging markets which are exposed to US interest via Dollar-denominated loans. Such pressure could prople the greenback even higher.

Conclusion

The US inflation report is a crucial event for currency markets and for the Fed. An acceleration to 2.2% in the Core CPI could boost the US Dollar ias it is well-positioned for further gains. 

More: 5 critical events in 50 hectic hours - everything you need to know