Following the last FOMC meeting, it seemed the Fed was quite happy with how much inflation was coming down.

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The rhetoric shifted from “keep raising” to “only a couple more hikes left”. That was a dovish shift that was welcomed by the risk-on side, to the detriment of the dollar. The Fed is still very much data dependent, as affirmed by Powell’s latest comments. And there isn’t any other data point that is less important to monetary policy at the moment than CPI figures.

The dollar index and yield curve points to increased expectations that the Fed can pull off a soft landing. That is reliant on a general perception that inflation will come down fast enough. Although there is a consensus that inflation will remain above target for the rest of the year, it’s expected that CPI will continue its lowering trend.

What the forecast is

Headline CPI is expected to come in at 6.3%, down from the 6.5% prior. But what the Fed cares more about are the core numbers. Here, the expectations are for a break in the trend, with inflation excluding energy and food prices to come down faster than the headline number. Core CPI change is expected to drop to 5.4% from 5.7% prior.

That would be good news for the Fed, and could continue to support the general move in favor of risk that was damaged a bit by the surprise jobs numbers released on February 3. Naturally if inflation numbers were to be even lower than expected, it would further the outlook that the Fed won’t hike as fast. We could see an even weaker dollar, and a surge in commodity currencies.

What’s the catch?

Of course there is also a risk that inflation will come in hotter than expected. We have to remember that a lot was made out of the prelim December monthly CPI change, which came in negative for the first time in over a year. There was even talk of deflation. That is, until the figure was revised higher, showing that the initial result – and the accompanying optimism – was out of place.

One of the key elements here has been the price of used cars, which has shown substantial volatility in the post-pandemic era. That contributed to lowering core inflation previously, but limited information from dealership surveys in January suggests that used cars have gone up in price recently. That could dampen some of that acceleration to the downside seen in core inflation.

Housing is still an issue

The other factor is the varying price in shelter, which basically means rental prices. Rent fell substantially in the latter half of last year as mortgage rates rose, pushing down house prices. But since the Fed has started to soften its stance, the trend in long-term interest rates has reversed, and there has been a little bit of recovery in the housing market.

That could translate into an unexpected increase in rent prices, and also push core inflation higher than expected. But, it might be too early for the housing price effect to translate into rents.

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