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The latest inflation figures put a twist on expectations for Wednesday's FOMC meeting with serious talk of a 75 basis point hike, and bigger moves going forward.

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What changed everything

Last Friday, the markets got a douse of cold water after the US inflation data came in above even the highest estimates. Markets tanked as analysts reevaluated how effective the Fed has been at controlling prices. The move in CPI figures shows that March's "peak" was a mirage. But there is some consolation for the Fed in the figures.

Core inflation, which is what regulators care about, actually fell, even though it did come in a decimal above expectations. This suggests that inflation is being driven in large part by higher gas prices. And this could be attributed in part to timing since gasoline prices for the CPI basket are sampled at the start of the month, which coincided with a spike in crude prices.

What happens now?

CME's FedWatch showed a dramatic shift in expectations for markets. Before Friday, there was a near-unanimous consensus that the Fed would hike by 50bps. Now over a quarter expect a 75bps hike. 

Most importantly, however, is likely to be the press conference following the rate decision, where investors will be keen to see if there is any change in the Fed's outlook. Previously, the idea was that there would be another 50bps hike in July and then the Fed would evaluate where to go ahead of the Jackson Hole Symposium. Now, the question is whether Powell will hint at possible steepening of the rate hike trajectory, which could further impact stocks and risky currencies. On the other hand, if he keeps the same tone as before, it could reassure investors and supply something of a relief rally. 

USDJPY overextended

The greenback has done extremely well against the Japanese yen in 2022. In February, USD/JPY accelerated after the pair tagged the 50-week average near 114.30, extending 20% higher for a 20-year high at 135.20. But, momentum has recently started to wane (as the RSI shows below).

So far this week 135.20 and 133.50 are top and bottom. A quiet start as investors patiently wait for the event. Post-FOMC, a breakout is expected.

An upward breakout could lead the pair up to 138.00. This is where the inverse Fibonacci retracement of the 114.30-131.40 leg lies. And above there, 140.00 is a major round resistance. Inversely, breaking the weekly support would expose 124.00 and 117.00. These two are the 20 and 50-week averages – respectively. 

Short-term, 130.90 is last week’s open, and 132.50 is where sentiment might change.

Source: SpreadEx

Key takeaways 

The Fed has been less successful than previously thought (hoped) in controlling inflation and hike expectations have tilted to the upside. Interestingly, the effect is being driven mostly by gas prices which is more important for regulators. As a result, markets expect a more aggressive tone, but the Fed might prefer to maintain its tone, offering a relief rally, unless it hikes 75-basis points.