US May CPI Preview

With all eyes on what the Fed will do at its meeting next week, the question is whether the latest inflation data will solidify the idea that it has peaked, or simply paused.

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Pivotal for the next hike

After NFP came in near the top of the range of expectations, comments from Fed officials sound pretty confident about voting for a 50-basis point hike on Wednesday. Almost 93% of analysts are in agreement that's what the FOMC will decide to do (with the dissenters expecting 75bps).

If core inflation comes in at or below expectations, then it could be seen that tighter policy is starting to have an effect. That means traders might be more interested in looking forward to when the Fed will take a breather in its aggressive hikes. A majority of traders are still expecting at least another 50 bps in the July meeting. But after that is the Jackson Hole Symposium, which is traditionally seen as the venue for a shift in monetary policy. 

What to look out for

Headline inflation is expected to remain at 8.3% y/y, with a monthly expansion of 0.7%. But that is expected to be largely due to fuel price increases. Core inflation, the one tracked by the Fed, is expected to decelerate substantially to 5.9% from 6.2% prior. Monthly inflation is expected to affirm that trend, if not as firmly, dropping to 0.5% from 0.6%. 

Generally, softer inflation (even if still very high) would curtail bets the Fed will be as aggressive in hikes, which could weaken the dollar in comparison to its major trading partners. 

With the BOE expected to keep facing inflation pressure, this could widen the expectation for the rate gap between the dollar and sterling. So far this month, the yield spread has remained relatively flat. But if inflation between the two countries is expected to diverge, it could give some support to cable.

GBP/USD H&S to play out?

From a technical standpoint, cable trades at a critical junction just shy off the 50-day moving average near $1.26. But an inverse head-and-shoulders reversal pattern could boost the pair up to $1.30 if the neckline at 1.265 and the 50 DMA give way. 

Of note is the right shoulder's bullish engulfing candlestick printed on Wednesday, as not only did it break above a 4-day range, but it also scooped stops below its range low. Stop-hunting at such a point in time often leads to either increased volatility or reversal.

If $1.2430 is revisited and gives way, then the $1.2150 yearly low comes back on the table. Below there an attempt at $1.20 will become more likely.

Key takeaways 

Economists and investors are confident in a 50-basis point hike from the Fed next week, but traders are expecting an equal hike in the July meeting. The CPI figures will play a critical role in how the Fed approaches in July and onwards.

Headline inflation is expected to remain unchanged but core inflation is to decrease significantly. This may change the current sentiment for July and weaken the dollar- or at least pause the uptrend - against the pound and other forex counterparts.