- This week's FOMC minutes are likely to suggest that a rate hike in December is coming
- Inflation numbers are more interesting, as expectations are pointing to higher inflation in the future
- Government spending remains the strongest driver of higher inflation, and Trump has yet to deliver
Given the relatively quiet start to this week, trading will remain light until important data is announced later this week. For the US dollar, markets will be closely watching Wednesday’s FOMC minutes and Friday’s Consumer Price Index figures.
December hike? Looks like a done deal
Expectations for a rate hike in December are running very high, with CME’s FedWatch Tool indicating an 86.7% probability of the Fed hiking rates by 25 basis points on December 13. The tool uses 30-day Fed Fund futures pricing data to calculate the probabilities, which are seen as the market’s view of future interest rates.
Despite some dissenting voices from Federal Reserve voting members, a significant change in the Fed’s inflation outlook from this Wednesday’s minutes would be a big surprise (and a dollar negative). Given the Fed’s historical tendency to telegraph its intentions well in advance of making any changes to its policies, the highest likelihood outcome is that Wednesday’s minutes will mostly reiterate what the Fed has communicated in the past. Thus markets are likely to be correct and a December rate hike looks like a ‘done deal’. The impact for the USD is likely to be minimal.
A jump in inflation numbers beyond estimates could get interesting
The more interesting data point this week is Friday’s CPI announcement. Looking at indicators that tend to front-run inflation, such as 5-Year, 5-Year Forward Inflation Expectation Rates or the Dow Jones-UBS Commodity Index suggests that inflation is set to rise. Year-on-year CPI figures for August came in at 1.9%, and current consensus expectations are only pricing in an increase to 2% for September. Thus this week’s inflation figures may be higher than current expectations. An overview of 5y5y rates are shown below:
The trajectory of inflation is changing
Inflation expectations shot up following Trump’s victory in the elections, and moved higher until late March. Following the disappointment of the healthcare vote, inflation expectations fell fairly quickly. After bottoming in late June, expectations have been gradually increasing. Given the strong historical correlation between inflation front-runners and actual inflation rates, inflation should thus move up in the near future.
Unfortunately, even if this week’s inflation figures are much stronger than expectations, they will once again be influenced by the impact of the recent hurricanes. Similar to last week’s non-farm payrolls data, the impact on the dollar may be limited if the Fed chooses to overlook the data.
Stronger inflation will help USD, but only Trump himself can bring back the Trump trade
While it’s too early to call the return of the Trump trade, the dollar is likely to get some much-needed support from rising inflation. With commodity prices increasing since last summer and the Fed set to hike rates in December, the longer term US dollar bear market looks like it bottomed in September.
As we wrote previously, government spending is a big driver of inflation. Trump will need to get at least part of his tax reform package through Congress for inflation expectations to rise higher, ultimately catalyzing another dollar rally. As markets are still waiting for the White House to finish drafting a tax plan that looks acceptable to most Republicans, the Trump trade remains on hold.