US Consumer Price Index set to soften in July, helping Federal Reserve policy pivot

The US Consumer Price Index is forecast to rise 2.9% YoY in July, at a softer pace than June’s 3% increase.
Annual core CPI inflation is expected to soften to 3.2%.
The inflation data could influence the probability of a 50 bps Fed rate cut in September.

The Bureau of Labor Statistics (BLS) will publish the highly anticipated Consumer Price Index (CPI) inflation data from the United States (US) for July on Wednesday 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 cut expectations in September.

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 2.9% in July, down slightly from the 3% rise reported in June. The core CPI inflation, which excludes volatile food and energy prices, is seen ticking down to 3.2% from 3.3% in the same period.

Meanwhile, the US CPI is set to rise 0.2% MoM in July after declining by 0.1% in June. Finally, the monthly core CPI inflation is forecast to print 0.2%.

The disappointing jobs report from the US, which showed that Nonfarm Payrolls rose 114,000 in July, revived expectations for the Federal Reserve to cut the policy rate multiple times this year starting in September. Following the July 30-31 policy meeting, Fed Chairman Jerome Powell refrained from confirming a rate cut in September but noted that there was a “real discussion” about lowering the policy rate at that meeting. Additionally, Powell acknowledged that they are attentive to risks on both sides of the dual mandate.

According to the CME FedWatch Tool, markets are currently pricing in a nearly 50% probability of a 50 basis points (bps) rate cut in September.

Previewing the July inflation data, “while gaining some momentum, we expect core CPI prices to remain largely under control in July after registering an unexpected contraction in June,” said TD Securities analysts in a weekly report and added:

“Headline inflation likely strengthened m/m as well as energy prices are expected to rebound post sharp declines in May/Jun. Our unrounded core CPI forecast at 0.14% m/m suggests larger risks toward a rounded 0.2% increase.”

Economic Indicator

Consumer Price Index ex Food & Energy (MoM)

Inflationary or deflationary tendencies are measured by periodically summing the prices of a basket of representative goods and services and presenting the data as the Consumer Price Index (CPI). CPI data is compiled on a monthly basis and released by the US Department of Labor Statistics. The MoM print compares the prices of goods in the reference month to the previous month.The CPI Ex Food & Energy excludes the so-called more volatile food and energy components to give a more accurate measurement of price pressures. Generally speaking, a high reading is seen as bullish for the US Dollar (USD), while a low reading is seen as bearish.

Why it matters to traders?

The US Federal Reserve has a dual mandate of maintaining price stability and maximum employment. According to such mandate, inflation should be at around 2% YoY and has become the weakest pillar of the central bank’s directive ever since the world suffered a pandemic, which extends to these days. Price pressures keep rising amid supply-chain issues and bottlenecks, with the Consumer Price Index (CPI) hanging at multi-decade highs. The Fed has already taken measures to tame inflation and is expected to maintain an aggressive stance in the foreseeable future.

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

The market anticipation of a 50 bps Fed rate cut in September will be put to test when July inflation data is released. In case the monthly core CPI, which is not distorted by base effects and the prices of volatile items, rises 0.3% or more, investors could lean towards a 25 bps rate reduction at the next Fed meeting. The market positioning suggests that such a reading could trigger a rebound in the US Treasury bond yields and help the US Dollar (USD) gather strength against its rivals with the immediate reaction.

If the monthly core CPI rises less than expected, market participants could remain hopeful about a 50 bps cut in September. In this scenario, the USD is likely to come under renewed selling pressure.

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 suggests that the bullish bias remains intact, with the Relative Strength Index (RSI) indicator on the daily chart holding comfortably above 50. Additionally, the pair staged a decisive rebound after testing the 20-day SMA last week, reflecting the sellers’ hesitancy to commit to an extended decline.”

“On the upside, 1.0950 (static level) aligns as interim resistance before 1.1000 (psychological level, static level). If EUR/USD manages to flip 1.1000 into support, it could target 1.1140 (December 28, 2023, high) next. Looking south, immediate support could be identified at 1.0880 (20-day SMA) ahead of 1.0830 (200-day SMA) and 1.0800 (100-day SMA).”

US Dollar FAQs

What is the US Dollar?

The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022. Following the second world war, the USD took over from the British Pound as the world’s reserve currency. For most of its history, the US Dollar was backed by Gold, until the Bretton Woods Agreement in 1971 when the Gold Standard went away.

How do the decisions of the Federal Reserve impact the US Dollar?

The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.

What is Quantitative Easing and how does it influence the US Dollar?

In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.

What is Quantitative Tightening and how does it influence the US Dollar?

Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.

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