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US inflation is expected to fall but could provide a good argument for another Fed rate hike. Investors will be looking to see if the next round of data will confirm the push already seen from NFP toward another hike. This comes in the context of the Fed’s survey of banks that saw weakening credit demand pointing to slowing economic dynamism.

One of the mitigating factors is that there are still another 36 days until the next Fed meeting, which means there will be another round of jobs and inflation numbers. They could change how the Fed reacts, so traders could moderate some of the impact from the upcoming numbers in the expectation of some revisions before the next Fed meeting. But, a substantial difference from expectations could set up the dollar for the rest of the month.
 

The trend toward tightening

The main takeaway from the last meeting of the FOMC was that they expected to pause unless there was a shift in the data that would warrant another hike. That set things up with over 90% of traders expecting a pause at the next meeting.

But then the higher-than-expected NFP came out last Friday, and the number of people expecting a hike at the next meeting doubled. It’s still over 80% of traders who expect a hike, but if inflation comes in hotter than expected, it could keep pushing that trend. US yields have already been moving higher over the last several sessions, and a further move in the tightening direction could give the dollar wings.
 

What to look out for

Because of base effects, annual inflation would have to come down to maintain a favorable trend. Just staying at a similar rate would imply rising inflation as last April saw such a large jump in prices. A beat over expectations could lead many to speculate that the Fed will be forced to raise rates to regain credibility in fighting inflation. But a miss would likely reverse the latest yield growth, as the number of traders expecting a rate hike could drop dramatically.

In any case, the monthly April headline CPI change is expected to accelerate to 0.3% compared to 0.1% reported in March. The annual rate is expected to come down slightly to 4.9% from 5.0%, which would maintain the key ratio of inflation being below the interest rate, seen as necessary to bring it back to target. Of course, a headline rate at or above 5.3% would likely shock the system as it would imply the need for higher rates.
 

The Fed outlook

In terms of monetary policy, the Fed cares more about the core rate, where there is a more optimistic situation. Monthly core inflation is expected to tick down to 0.3% vs 0.4% prior. But the annual rate is expected to remain steady at 5.6%, near triple the target rate, which could keep pressure on the Fed to hike.

For now, however, it appears the Fed is relying on the tightening impact of the banking crisis. Its recent survey of bank lenders showed that banks are tightening lending and are expected to make it more difficult for businesses to obtain loans for the rest of the year. This has the practical impact of hiking rates as far as inflation is concerned.

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