US CPI preview: Markets sanguine as we lead up to key data

All eyes will be on the US inflation report later today. The CPI report for January is released at 1330 GMT and is expected to show a 0.3% gain for headline CPI last month, the annual headline rate is forecast to remain steady at 2.9%, and core price growth is expected to moderate a notch to 3.1% from 3.2%. The lead indicators for inflation have been mixed: wage data was stronger than expected for last month, however, the Service sector ISM prices paid index fell to 60.4 down from 64.4. This reverses the surprise spike in prices paid in December.

Bar a major surprise in today’s price data, one month’s worth of data is unlikely to sway the Federal Reserve. Fed chair Jerome Powell told Congress that a strong economy and inflation that remains above target will make it hard for the Fed to cut interest rates. He also reiterated the message from the last FOMC meeting that the  Fed will remain on hold for some time. The President of the NY Fed, John Williams, also said on Tuesday that rate setters in the US need to wait and see what the economic data does over the coming months before making changes to monetary policy.

How financial markets react to the CPI report

With interest rates on hold for the foreseeable, regardless of tomorrow’s CPI data, it could limit the extent of the market reaction. However, CPI is a major market release, and it can have a big impact on financial markets, at least in the short term. Over the last 12 months, the average impact on the S&P 500 has been very small in the 1 hour after a CPI release, however, inflation surprises can have a big impact on the S&P 500. For example, worse than expected inflation reports last Autumn saw a large decline in the S&P 500 of more than 1.5% in the hour after the release.

There are signs that the market may be preparing for a stronger than expected January inflation report. For example, the inflation swaps market has been creeping higher. The 5-year rate is considered a good proxy for inflation expectations, and this have risen sharply since December.  This is one way the market likes to express its belief about the future for US price growth. However, if the CPI report comes in weaker than expected this could shock financial markets.  Overall,  we consider this a low probability event. We think that inflation may come in around expectations, or maybe a notch higher, and this is why the Federal Reserve is sticking to its view that rates will be on hold for some time.

Elsewhere, the FX market tends to be less impacted by the CPI reports, and the average move in the US dollar index in the hour after a CPI release over the last 12 months is negligible. USD/JPY is the most sensitive, and its average move has been 0.2%. The upper bound is 0.5%, and the lower bound is -0.8%. USD/JPY tends to fall more frequently than rise during CPI releases over the last 12 months. This suggests that USD/JPY is sensitive when there is a negative inflation surprise, so watch out for prices rising more than expected. This could trigger safe haven flows to the JPY, as traders and investors worry about prolonged high interest rates in the US.

The market reaction

Leading up to the CPI report, 2-year US Treasury yields are mostly stable, and have  moved higher by a mere 5bps in the past month, and 10-year yields have fallen a touch. This is also a symbol of the Fed remaining on hold for some time. While investors are getting tariff fatigue and are willing to look through Donald Trump’s wide-ranging tariffs, the next driver for risk assets could be inflation and what it means for the future direction of monetary policy.  

Ahead of this report, US stock index futures are down slightly. A weaker than expected CPI report could trigger a rally in stocks. Unusually, the US blue chip indices are lagging behind European indices. For example, over the past month, the S&P 500 is higher by just over 4%, while the Euro Stoxx index is higher by 9.5%. A moderation in price pressures could boost overall risk assets and it may also allow a broader stock market rally in the US, after a slight bias to tech at the start of this week.

The dollar is also fading as we lead up to the CPI report. It is weaker vs. most of the G10 FX space, and it has only managed to eke out gains vs. the yen and the NOK as the FX market becomes less risk averse and more willing to accept Trump’s tariff uncertainty.

Inflation and the Gold price

It is also worth watching the commodity space on Wednesday. So far, the oil price has failed to react to the potential for the Israel/ Hamas truce to unravel. The oil price is lower today.  The gold price has found resistance around $2,900, which is proving to be a difficult level to break, and the gold price is lower today. As we have mentioned, gold tends to move sideways around key psychological levels like $3000. However, gold is an inflation hedge, and it may move on the back of today’s CPI report. While the average move in the gold price on the back of CPI is small over the last 12 months, it has had some strong reactions, particularly when inflation is stronger than expected. Thus, the CPI report could determine where gold goes next, at least in the short term.