The US Bureau of Labor Statistics will release the Consumer Price Index (CPI) figures for November on Tuesday, December 13. The US Dollar has been having difficulty staying resilient against its rivals since mid-October. The inflation report ahead of the year’s last Federal Reserve policy meeting could significantly impact the currency’s valuation.
On a yearly basis, the CPI is forecast to decline to 7.3% and the Core CPI, which excludes volatile food and energy prices, is expected to edge lower to 6.1% from 6.3%. On a monthly basis, the Core CPI is projected to match October’s print of 0.3%.
The monthly Core CPI will likely be the figure that market participants will pay the most attention to because it will not be distorted by the base effect. Additionally, it will not reflect the more-than-6% decline witnessed in crude oil prices in October.
In case monthly Core CPI in October arrives at 0.5% or higher, investors are likely to reinstate their US Dollar longs with anticipation that this data could cause Fed policymakers to pencil down a higher-than-5% terminal rate even if they vote for a 50 basis points rate hike on Wednesday. On the other hand, a reading of 0.3% or lower should feed into the ‘Fed pivot’ narrative and trigger a US Dollar sell-off. Although FOMC Chairman Jerome Powell is likely to continue to push back against the market expectation for a policy reversal via rate cuts in 2023, a soft monthly CPI for the second straight month could revive optimism about inflation having peaked in the US. Hence, some policymakers could see lower inflation in 2023 in the Summary of Projections (SEP) and refrain from projecting a terminal rate of higher than 5%.
It’s worth noting that even if the US Dollar comes under renewed selling pressure on a weak CPI print, the Euro and Pound Sterling could struggle to capture the capital outflows amid uncertainties surrounding the European Central Bank (ECB) and the Bank of England’s (BoE) policy decisions, which will be announced on Thursday. In that scenario, Gold price could be the main beneficiary due to its inverse correlation with the benchmark 10-year US Treasury bond yield. USD/JPY could also show a strong reaction and fall sharply on growing expectations about the Bank of Japan (BoJ) finally looking to exit from its ultra-loose policy. On the flip side, a hot inflation report is likely to weigh heavily on both EUR/USD and GBP/USD.
Gold Price technical outlook
XAU/USD’s short-term technical outlook paints a bullish picture with the Relative Strength Index (RSI) on the daily chart holding comfortably above 50. The fact that the daily RSI also stays below 70 suggests that the pair has more room on the upside before turning technically overbought. Furthermore, the 200-day Simple Moving Average (SMA) stays intact at around $1,790, confirming sellers’ unwillingness to commit to an extended decline for the time being.
With a soft inflation report, Gold price could target $1,830 (Fibonacci 50% retracement of the long-term downtrend) and $1,860 (static level) next. On the other hand, $1,780 (Fibonacci 38.2% retracement) could be tested with a strong monthly Core CPI print before $1,770 (static level, 20-day SMA).
IN DEPTH ANALYSIS OF TODAY’S US CORE CPI DATA
“King of forex indicators” is how the Nonfarm Payrolls report was called, but that belongs to the past. In 2022, rising inflation has meant that the Consumer Price Index (CPI) report has the most significant impact.
The last release in 2022 is due out just one day before the Federal Reserve announces its decision and also publishes new forecasts. Fed Chair Jerome Powell is set to oversee a 50 bps rate hike – lower than 75 bps, but alongside a promise to continue hiking next year.
An extreme outcome can change the rate decision, and even a small deviation could impact Fed members’ forecasts. The bank’s focus is on Core CPI – price rises excluding energy and food. The monthly figure stood at 0.3% last time, causing markets to cheer after two miserable rises of 0.6% in the previous two months.
This time, the economic calendar points to a rise of 0.3%. That may or may not be too optimistic and is one of five scenarios.
1) Positive surprise, 0.2%
If underlying inflation not only remains low but decelerates, the US Dollar would tumble and stocks would cheer. It would imply an annualized rate of 2.5%, something the Fed and Americans would love to see.
The reason for such a drop would be the unsnarling of supply chain issues, which have been driving up the prices of goods. However, this scenario seems highly unlikely given the overall health of the US economy.
In such a case, Fed officials might be open to ending the rate hike cycle as soon as February, but once again, chances are low.
2) As expected, 0.3%
A repeat of October’s low figure would prove that it was not a one-off, and that inflation is genuinely slowing down. It would keep the option of a 50 bps hike in February open, but would still cheer markets and send the Dollar down. After an initial decline, the Greenback would stabilize.
We see a medium probability of this scenario, given economists’ expectations, which seem too optimistic to me. The increases in services prices look sticky, insufficient for another month of annualized inflation at under 4%. That will probably take more time.
3) Small beat, 0.4%
While such an outcome would ostensibly be Dollar positive, I see it as neutral. Using annualized numbers once again, it would reflect an increase of roughly 5.0%, which is significantly below the current YoY level of 6.3% and still proof that last month’s 0.3% was not a one-off.
On the other hand, it would show that the war against inflation has a few more battles in store, and that the Fed would hike by 50 bps in February before potentially stopping.
In this scenario, the Dollar would initially bounce on the beat before selling on the decline in comparison to the previous month. I give this outcome a high probability.
4) Bigger beat, 0.5%
While this would be one-tenth below the stubborn 0.6% reads for August and September, such an outcome would reflect a sticky annualized underlying inflation level of nearly 6%. That is bad news for Americans and for markets.
It would also be a significant beat of expectations, boosting the Dollar and keeping it elevated ahead of the Fed. The bank would then signal a near-certain 50 bps increase for February and probably point to ending 2023 with a rate above 5%.
We give this scenario a medium probability.
5) Back to the drawing board, 0.6%:
A return to those nasty jumps – reflecting an increase of 7.2% annualized – cannot be ruled out. I see it as having a low probability but above the chances of a 0.2% increase. Why?
Americans keep on buying goods and also consume services and experiences. There is still too much excessive cash in shoppers’ pockets, and the drop in gasoline prices leaves more free cash to spend on other things.
In such a scenario, the Dollar would jump and then continue rising, settling only close to the Fed decision. Some would speculate about another 75 bps hike – highly unlikely, but Fed Chair Jerome Powell could signal two more 50 bps hikes in early 2023. Markets would be devastated.
Final thoughts
November’s CPI report comes at a sensitive time and that adds to the complexity. Every tenth matters not only for the initial reaction but also for the positioning ahead of the Fed.
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