Can US inflation data surprise? How can they affect stocks and the dollar?

The beginning of the week in the markets in Europe was calm and did not bring major changes, although we observe a slightly negative bias and a slightly stronger US dollar, as markets await today's CPI report for April. Will this one surprise today?

Following the positive non-farm payrolls report late last week, we are seeing a shifting away from the widespread expectation that once the Federal Reserve completes its current rate hike cycle, rate cuts probably won't be too far away, especially given market concerns about US regional banks.

A key benchmark

The economic data we've seen over the past few days, especially the US labor market, suggests that the likelihood of this is even more remote, which has pushed the US dollar higher and US yields with it.

For most of the past few weeks, US stock markets, along with 2-year yields, have been in a horizontal range as investors try to determine which timing scenario for a US recession is more likely.

The tone of yesterday's trading was not helped by comments from John Williams of the New York Fed, who reminded the markets that the Fed did not unequivocally say that no more rate hikes, saying that there is no baseline scenario for rate cuts this year and that rates will continue to rise if inflation does not continue to decelerate at the required rate.

After the Federal Reserve raised rates again by 25 basis points last week, today's April data CPI are another key benchmark for assessing whether the Federal Reserve will hit the pause button at its next meeting and keep rates unchanged after several more hikes.

While the headline CPI fell to 5% in March from 6% in February, the picture of core prices it did not encourage a continuation of the sharp drop in inflation, and this is where the Fed wants to focus its attention.

Core prices increased in March to 5,6% from 5,5% y/y, bringing core inflation above headline inflation for the first time since January 2021.

It is this core price stickiness, as well as the resilience of the US labor market, that makes the Fed's task so difficult, even considering the fact that over the past 12 months we have witnessed the US central bank raise rates at every meeting.

Of course, if underlying prices start to hold their current levels, it could reinforce the argument that prices are close to peaking. Today's inflation report is expected to stay at 5%, while core prices are expected to fall from 5,6% to 5,5%.

Even if we don't see significantly weaker data today, May's inflation and employment figures will remain until the next Fed meeting, and there is reason to be optimistic about price declines given the behavior of the US PPI in recent months - in March it fell to 3,4%, and a year ago it was as much as 9,6%.

Possible impact on the market

If inflation remains higher than expected, fears of an inflationary spiral may increase, which will force the Fed to continue raising rates. Bonds could fall and drag stock markets down due to increased uncertainty.

Conversely, a lower than expected figure would be a signal that the Fed's recent pause at 5,25% is a wise move. In this case, bonds could gain and stock markets would breathe a sigh of relief as uncertainty decreases. In this regard, it should be noted that sentiment is bearish, and short positioning high, which may lead to hasty closing of shorts or short squeezeif the stock markets that are at the top break resistance.

In the currency markets, the USD could regain ground if bond yields rise again and interest rate spreads with other currencies widen. Conversely, if inflation subsides and US bond yields fall, narrowing the spread, the USD could lose ground.

It is also worth remembering that the current US inflation reading may also be affected by the earlier OPEC decision, which temporarily boosted oil prices. This event pushed fuel prices up in the US until mid-April.