Fed Hinges on How Fast CPI Falls

Markets appear to be pricing in a soft landing for the US as inflation is expected to keep falling and relieve pressure on the Fed to raise rates.

It's All Up to the Data

Following its last meeting, the Fed said it would take a data-dependent approach to its next rate hike. The consensus among Fed officials is that there should be one more rate hike this year. The market still believes that the Fed won't go through with it. One of the points that could resolve that is how fast inflation comes down after Fed officials said that the latest jobs numbers didn't change the outlook. It should be pointed out that there will be another inflation data release before the Fed meets again.

The last release of inflation numbers fell well below expectations and helped push markets higher. Many traders were worried that the Fed would overtighten and risk tipping the economy into a hard landing. As inflation approaches the target rate, markets have become more optimistic.

What Are the Forecasts

The consensus is that the headline inflation rate will suffer a minor reverse, ticking back to 3.1% from 3.0%, as previously reported. However, that is due to base effects, as the monthly inflation rate is expected to show an unchanged expansion of 0.2%, above the ratio reported for the same month last year. Where the Fed pays particular focus is on the core rate, which is expected to remain unchanged at 4.8%, with the monthly rate also unchanged at 0.2%. A significant move higher could bring back the risk-off environment as markets might start to accept that the Fed will hike again. But another substantial miss like last time could move the markets back into risk-taking.

One of the issues that could prove to be problematic is the increasing cost of crude through the month of July, which has already been felt at the pump. That could keep the headline rate buoyant while wages have finally grown faster than inflation. With average earnings growing at over 4.0% annualised, the Fed might be willing to ignore largely in-line inflation data and focus on the overheated jobs market that's keeping core inflation from coming down to target.

EUR/USD in Potential Falling Wedge

A falling wedge pattern appears to have completed forming at $1.0912, pending a deep correction towards $1.1150, followed by further declines that expose $1.0636. If $1.1040 holds firm, the pattern would be either invalid or the correction too shallow. A surge higher could open the door to $1.1275 while sliding under $1.0910 and $1.0830 promptly might see prices descend to $1.0780 sooner than liked.

Source: SpreadEx / EURUSD

Key Takeaways

Markets are cautiously optimistic about a soft landing for the US economy, as inflation is expected to continue falling. This would relieve pressure on the Federal Reserve to raise interest rates. The upcoming release of inflation data will be crucial in determining the Fed's next moves, with market expectations divided on whether there will be another rate hike this year. The core inflation rate, wage growth, and the job market will influence the Fed's decision-making process. Overall, market sentiment hinges on how fast inflation decreases and whether it aligns with the Fed's outlook.