It’s all about inflation this week, US inflation specifically. In order to see the significance of Thursday’s PCE print we need to see the context of the US inflation story. So, this article will give a broad skeleton on that context and show what the key focus is going to be. There are finer points to this context that this piece will not focus on in the interests of time considerations.

Context is king

For the last few weeks, the market has been wanting to know when the Fed will pause rates. The Fed has sent mixed messages. Sometimes it seems to stress monetary policy lag, while at others it stresses the need to bring inflation down. The Fed runs with the hares and the hounds, playing the possibilities of both options because it has to. However, the helpful aspect for traders is that when a data point gives a clear hint at what is coming there is usually a strong asset movement. So, last week the FOMC minutes showed that the Fed now saw a US recession for 2023 as pretty much a ‘base case’. This was a surprise revelation and allowed market to take comfort in the fact that most Fed members advocated for a slowing path of US rates. Stocks rose and the USD fell as would be expected.

So, the Fed is slowing, right? Not if inflation remains high. The Fed is determined to tackle inflation and if inflation keeps rising then the Fed will keep hiking. So, this is great news for traders ahead of the core PCE print. Why? Because if the next inflation print shows a big deviation the likely market reaction is highly predictable.

What’s the deviation to look for?

The core PCE y/y reading is expected to be 4.9% y/y down from 5.1% prior.

The core PCE Price Index is expected to fall to 5.9% down from 6.2% prior. So, the expectations are for a drop in inflationary pressure and that should be a selling pressure on the USD (remember that the USD can move for other reasons too).

If the reading comes in above 5.2% for the core and above 6.4% for the Price index then it is reasonable to expect a possible USD strength, EURUSD downside, gold selling, and S&P500 selling.

However, if the reading comes in below 4.6%% for the core and below 5.9% for the Price index then it is reasonable to expect a possible USD weakness, EURUSD upside, gold buying, and S&P500 buying.