MUFG’s Lee Hardman highlights that the stronger United States (US) Producer Price Index (PPI) data has reinforced expectations for a Federal Reserve (Fed) rate hike, with around 18 bps now priced for next week’s FOMC meeting. He notes that today’s US Consumer Price Index (CPI), especially core CPI at a forecast 0.2% M/M, will be crucial for US rate expectations, the Dollar and US Treasuries.

CPI print key for Fed path

The sell-off in global bond markets was also reinforced by the release of the stronger than expected US PPI report for August which has added more weight to the case for the Fed to begin hiking rates next week.”

“There are now 18bps of hikes priced into the US rate market ahead of next week’s FOMC meeting up from 13bps at the end of last week highlighting that market participants are now leaning more heavily in favour of a hike.”

“The PPI report revealed that the components that feed into the PCE deflator were firmer than expected. According to Bloomberg, they are likely to add close to 0.1ppt to the August print. Healthcare costs rose by 0.3%M/M and airfares by 3.2%M/M.”

The stronger PPI report makes it even more important that the release of today’s US CPI report comes in softer than expected if the Fed is to keep rates on hold for longer while the energy price shock is getting worse. The dollar index initially strengthened after the US PPI report was released but has quickly given back those gains.”

“The key focus today will be on the core CPI reading. The consensus forecast is for a reading of 0.2%M/M. If the reading is in line with the forecast or stronger the US rate market will continue to expect the Fed to hike rates supporting the USD. Whereas a softer reading could trigger a bigger sell-off by encouraging the US rate market to scale back Fed rate hike expectations while other major central banks are expected to continue tightening policy.

“If the Fed stays on hold for longer it could fuel fears that it is falling behind the curve weighing more heavily on the US dollar and long-term US Treasuries.”