US CPI inflation data could alter market expectations of the Fed interest rates

• The US Consumer Price Index is forecast to rise 2.3% YoY in September, at a softer pace than August’s 2.5% increase.
• Annual core CPI inflation is expected to hold steady at 3.2%.
• The inflation report could ramp up USD volatility by altering the market expectation of the Fed outlook.

The Bureau of Labor Statistics (BLS) will publish the highly anticipated Consumer Price Index (CPI) inflation data from the United States (US) for September on Thursday at 12:30 GMT.

The US Dollar (USD) braces for intense volatility, as any surprises from the US inflation report could significantly impact the market’s pricing of the Federal Reserve (Fed) interest rate outlook for the rest of the year.

What to expect in the next CPI data report?

Inflation in the US, as measured by the CPI, is expected to increase at an annual rate of 2.3% in September, down from the 2.5% rise reported in August. The core CPI inflation, which excludes volatile food and energy prices, is forecast to stay unchanged at 3.2% in the same period.

Meanwhile, the CPI and the core CPI are anticipated to rise 0.1% and 0.2% on a monthly basis, respectively.

Previewing the September inflation report, “our forecasts for the September CPI report suggest core inflation lost modest momentum, registering a 0.24% m/m gain after advancing a slightly stronger 0.28% in August,” said TD Securities analysts in a weekly report, and added:

“Headline inflation likely lost meaningful momentum, as the energy component will again provide major relief. The details should show that core goods prices added to inflation for the first time in seven months, while housing inflation likely cooled modestly dragging core services inflation lower.”

Speaking on the Fed’s policy outlook recently, Fed Governor Adriana Kugler said that she will support an additional rate cut if the progress on inflation continues as expected. On a cautious note, St. Louis Fed President Alberto Musalem argued that the costs of easing the policy too much too soon were greater than the costs of easing too little too late. “That is because sticky or higher inflation would pose a threat to the Fed's credibility and to future employment and economic activity,” he further argued.

How could the US Consumer Price Index report affect EUR/USD?

Following the Fed’s decision to lower the policy rate by 50 basis points (bps) at the September meeting, investors expect the US central bank to dial down the degree of easing by opting for a 25 bps cut at the next meeting. According to the CME FedWatch Tool, the probability of a 50 bps rate reduction in November is completely ruled out for now. 

The upbeat employment data for September eased fears over a cooldown in the labor market, causing investors to refrain from pricing in a large rate cut. The US Bureau of Labor Statistics reported that Nonfarm Payrolls (NFP) rose by 254,000 in September, surpassing the market expectation of 140,000 by a wide margin. Additionally, the Unemployment Rate retreated to 4.1% from 4.2% in the same period, while the annual wage inflation, as measured by the change in the Average Hourly Earnings, edged higher to 4% from 3.9% in August. 

It will take a significant miss in the inflation data for investors to reconsider a large rate reduction at the next policy meeting. In case the monthly core CPI comes in at 0% or in negative territory, the immediate reaction could revive expectations for a 50 bps cut and trigger a US Dollar (USD) selloff. On the other hand, a reading at or above the market expectation of 0.2% should reaffirm a 25 bps cut. However, the market positioning suggests that the USD doesn’t have a lot of room on the upside. 

Eren Sengezer, European Session Lead Analyst at FXStreet, offers a brief technical outlook for EUR/USD and explains: “EUR/USD’s near-term technical picture highlights a lack of buyer interest, with the Relative Strength Index (RSI) indicator on the daily chart staying well below 50.”

“EUR/USD could face first support at 1.0930, where the Fibonacci 50% retracement of the June-August uptrend meets the 100-period Simple Moving Average (SMA). If this support fails, 1.0870 (Fibonacci 61.8% retracement, 200-day SMA) could be seen as the next bearish target before 1.0800 (Fibonacci 78.6% retracement). On the other side, interim resistance aligns at 1.1000 (Fibonacci 38.2% retracement). Once the pair flips this level into support, it could extend its recovery toward 1.1050-1.1070 (50-day SMA, Fibonacci 23.6% retracement) and 1.1100 (20-day SMA).”