US core CPI inflation expected to ease slightly ahead of Fed decision

• The US Consumer Price Index is forecast to rise 3.4% YoY in May, at the same pace as in April.
• Annual core CPI inflation is expected to inch lower from 3.6% in April to 3.5% in May.
• The inflation data could impact the US Dollar value and the September rate cut expectations.

The Bureau of Labor Statistics (BLS) will publish the highly anticipated Consumer Price Index (CPI) inflation data from the United States (US) for May on Wednesday at 12:30 GMT.

The US Dollar braces for intense volatility, as any surprises from the US inflation report could significantly impact the market’s pricing of the Federal Reserve (Fed) interest rate cut expectations in September.

What to expect in the next CPI data report?

Inflation in the US, as measured by the CPI, is expected to increase at an annual rate of 3.4% in May, at the same pace seen in April. The core CPI inflation, which excludes volatile food and energy prices, is seen at 3.5% in the same period,  a tad lower than the 3.6% figure recorded in April.

Meanwhile, the US CPI is set to rise 0.1% MoM in May, compared to a 0.3% growth in April. The core CPI inflation is likely to hold steady at 0.3% over the month in May.

Just a day before the April CPI data release, Federal Reserve Chairman Jerome Powell spoke at a moderated discussion at the Foreign Bankers' Association's Annual General Meeting in Amsterdam. Powell shifted to a dovish stance on the interest rates outlook, noting that "confidence in inflation moving back down is lower than it was. My confidence on that is not as high as it was before."

Powell added: "Don't think it's likely that the next move would be a rate hike, more likely that we would hold policy rate where it is."

The headline and core CPI inflation softened in April, justifying Powell’s commentary. Since then, a slew of US business activity and employment data added credence to the market’s pricing of a Fed interest rate cut in September.

That, however, changed following a robust US labor market report released on Friday, which showed that Nonfarm Payrolls increased by 272K jobs last month, against a predicted job gain of 185K. Average Hourly Earnings rose 4.1% in the same period, compared to the 4% increase in April, beating expectations for a 3.9% growth.

The data portrayed continued tightness in the US labor market conditions and an uptick in wage inflation, tempering bets for a September Fed rate cut. Markets dialed down bets of a 25 basis points (bps) rate cut in September to 43% from about 55% before the report, according to the CME Group’s FedWatch Tool, now pricing roughly an even chance of two rate cuts by the end of 2024 versus about a 68% chance seen before the NFP release, per Reuters.

Previewing the May inflation report, “we expect next week's CPI report to show that core inflation slowed again to a "soft" 0.3% m/m pace in May after posting a firmer 0.29% gain in April. The headline likely rose by a softer 0.1% m/m as energy prices likely provided large relief,” said TD Securities analysts in a weekly report.

“Note that our unrounded core CPI forecast at 0.26% m/m suggests larger risks for a dovish surprise to a rounded 0.2% increase,” the analysts added.

How could the US Consumer Price Index report affect EUR/USD?

Amidst a fall in energy prices during May, the monthly headline CPI and core CPI figure could see a downside surprise. However, the US Dollar’s reaction to the data release could be limited ahead of the all-important Fed policy announcements due later on Wednesday.

In case the monthly core CPI rises 0.3% or more, it could reinforce the market’s confidence that the Fed could extend the pause in September, especially after the impressive labor market data for May. In this scenario, the US Dollar is likely to see a further upside against its major rivals. Conversely, a downside surprise in the monthly core inflation to 0.1% or lower could rekindle hopes of a continued disinflationary trend, reinforcing September rate cut expectations and fuelling a renewed USD sell-off across the board.

Dhwani Mehta, Asian Session Lead Analyst at FXStreet, offers a brief technical outlook for EUR/USD and explains: “The Relative Strength Index (RSI) indicator on the daily chart holds below 50 ahead of the US inflation data, indicating a bearish outlook for EUR/USD in the short term. Further, the pair has broken below all the major Simple Moving Averages (SMA) on the daily time frame, adding to the downside bias.”

“If EUR/USD rises above the key supply zone near 1.0780, the confluence of the 200-day and 50-day SMAs, it could put the 100-day SMA at 1.0805 immediately to test. Acceptance above the latter could compel buyers to target the 21-day SMA barrier at 1.0843 before challenging the 1.0900 threshold. Alternatively, if the downside extends below the 1.0650 support, sellers will retest the April 16 low of 1.0601.” Dhwani adds.