Watch US inflation numbers to assess further rate hike possibilities

The FOMC has projected three rate hikes for this year; however, the actual path would depend a lot on inflation figures over the year. Today, at 13:30 GMT, December inflation figures will be released from the US.

Why important?

• Fed’s dual mandate is price stability and maximum employment. However, the unemployment rate has now reached 4.7 percent in the US, which is considered as very close to long-term unemployment level, consistent with Fed’s dual mandate. That leaves inflation to be the most vital mandate for subsequent hikes.

• As inflation expectations increase the fed has projected three rate hikes for 2017. Hence, the actual inflation would need to evolve in such manner to warrant hikes.

• Moreover, inflation numbers will be the key determinant of exchange rate divergence among major economies in the coming months and years.

Past trends –

• After staying below FED’s 2 percent target, headline CPI fell to negative territory in the final quarter of 2014. In January CPI fell by -0.7 percent on monthly basis, mostly due to lower energy prices. Yearly CPI fell by -0.1 percent y/y in January.
• Yearly change in CPI has been minimal since then, growing about 0.04 percent per month.
• Yearly CPI growth was +0.7 percent in December, the first sign of a comeback. In March it showed further signs of bounce back, with 0.9 percent y/y. Consumer price index was up 1 percent in June and 0.8 percent in July on a yearly basis. In August it picked up further to 1.1 percent y/y. It rose further in September by 1.5 percent and by 1.6 percent in October. It rose further to 1.7 percent in November.
• In addition to that, core CPI has been showing remarkable resilience, monthly growth not falling below zero since February 2010. In March, it grew 0.1 percent m/m and 2.2 percent from a year back and in June it grew by 2.3 percent. In October and November, it was up 2.1 percent y/y.

Expectation today –

• CPI is expected to grow 0.3 percent m/m and rise by 2.1 percent on yearly basis.
• Core CPI is expected to grow at 2.2 percent on yearly basis.

Impact –

• A higher than expected CPI inflation number could undercut the recent weakness in the dollar by firming up the rate hike expectations. That should push the dollar higher, which is currently trading at 100.6.
• The bigger impact could be felt in the bond market. Bond prices would decline if the CPI come higher than expected. US 10-year yield is currently at 2.36 percent.