Global markets await US inflation data

The US dollar retreated in Asian trading on Wednesday, as investors eagerly anticipated the release of the US Consumer Price Index (CPI) report. The data is expected to offer valuable insights into the Federal Reserve's potential interest rate adjustments.

Market analysts predict a slight moderation in headline CPI, but a persistent upward trend in core inflation is anticipated. This could complicate the Fed's decision-making process, as a larger rate cut could potentially stimulate the economy but also exacerbate inflationary pressures.

Meanwhile, in Japan, the Bank of Japan's board member, Junko Nakagawa, hinted at further interest rate hikes if economic conditions align with the central bank's forecasts. However, she also emphasized the need to carefully assess the potential impact on both the economy and price stability.

Dollar softens amid yield decline

The dollar's weakness was primarily driven by a decline in US Treasury yields. Investors appeared to be discounting the recent presidential debate, focusing instead on the highly anticipated CPI report.

Market expectations for CPI

Market consensus suggests that headline CPI will moderate from 2.9% to 2.6% in August. However, core CPI, excluding volatile food and energy prices, is expected to remain unchanged at 3.2%. This could indicate that disinflationary momentum is losing steam, with services and shelter costs keeping core inflation elevated.

Implications of CPI report

A downside surprise in the CPI report could increase the odds of a larger 50 basis point rate cut by the Fed at its next meeting. However, the market reaction could be complex: a significant undershoot in inflation could also signal weakening demand, raising concerns about a broader economic slowdown.

Market pricing for rate cuts

As of now, futures markets are pricing in a 33% chance of a 50 basis point rate cut, with the majority (67%) betting on a smaller 25 basis point cut. Looking further ahead, markets are already pricing in a total of 75 basis points in cuts by year-end, with a 90% chance of 100 basis points in reductions and a 53% chance of 125 basis points.

BoJ's stance on interest rates

In a speech today, Bank of Japan board member Junko Nakagawa indicated that the central bank will raise interest rates further if the economic outlook aligns with its forecasts. However, she also emphasized the need to carefully consider the potential impact of such moves on the broader economy and price stability.

Nakagawa acknowledged Japan's tight labor market and rising import prices as upside risks to the inflation outlook. While affirming that Japan's economic fundamentals remain strong, she highlighted the importance of "looking back upon market developments" following July's rate hike before making any further rate adjustments.