CPI and FOMC, who do you trust?

The US May CPI data fell short of expectations, causing the US dollar index to decline. However, the FOMC unexpectedly hawkish stance led to a rise in the US dollar and US bond yields. Most Federal Reserve officials still expect to cut interest rates once or less this year, possibly to stabilize the market and create an economic soft landing scenario of "strong employment + weak inflation". The CPI data was affected by the drop in oil prices in May, with super core services inflation experiencing negative growth for the first time. The FOMC dot plot shows that the number of rate cuts in 2024 has been adjusted from 3 times to 1 time, and the neutral interest rate in 2025 has been raised by 25 basis points

US CPI significantly below expectations, with the dollar index briefly falling to 104.25 after the data release and the 10-year US Treasury yield dropping by 15bp. However, the early morning FOMC unexpectedly hawkish, causing the dollar and Treasury yields to give back gains, but still lower than pre-CPI levels.

CPI significantly below expectations

May CPI overall and core both slowed significantly, falling short of almost all institutions' forecasts.

Overall CPI: MoM 0.0% (forecast 0.1%, previous 0.3%), rounded to 0.006%; YoY 3.3% (forecast 3.4%, previous 3.4%).

Core CPI: MoM 0.2% (forecast 0.3%, previous 0.3%), rounded to 0.163%; YoY 3.4% (forecast 3.5%, previous 3.6%).

Core services excluding housing: MoM 0.0% (previous 0.4%), rounded to -0.040%; YoY 4.8% (previous 4.9%).

Looking at the details, the drop in oil prices in May had a significant impact on CPI:

Energy MoM -2.0%
Housing MoM 0.4%, unchanged from the previous month, with rents and OER remaining sticky
Super core services inflation MoM -0.04%, the first negative growth in three years, mainly due to declines in transportation and entertainment, with concerns that summer travel may lead to a rebound in this inflation.

May US CPI breakdown

MoM US super core services inflation in May

FOMC dot plot hawkish

1. Overall upward shift in the dot plot. In the 2024 dot plot, the median shifted from 3 hikes to 1 hike: 4 members see no rate cut, 7 members see a 25bp rate cut, and 8 members see a 50bp rate cut; the 2025 dot plot median increased by 25bp; the long-term neutral rate also increased by 25bp.

Comparison of dot plots in March and June

2. Economic Outlook: The expectations for PCE and core PCE for this year and next year have been raised, with a slight increase in the unemployment rate expectations after 2025, while GDP forecasts remain unchanged.

Trading Ideas

Who to believe, CPI or FOMC? The combination of "CPI significantly below expectations + very hawkish FOMC" has caught the market by surprise. Despite most Fed officials still expecting a rate cut of 1 or fewer times this year after seeing the CPI report, it indicates that the Fed may continue to play a role in smoothing market volatility. On one hand, this may be to create an economic soft landing scenario for the US with "strong employment + weakening inflation" leading up to the November election, without wanting the US dollar to weaken too much.
The US dollar rates are still insufficiently priced into the dot plot, with US bond yields and the US dollar in focus. Currently, the futures market implies that the rates at the end of 2024 and 2025 are lagging behind the dot plot by 1 and 0.5 times respectively (see the chart below), suggesting that the expected rate cuts for 2024 may shift from 2 times to 1 time.

Short-term risk events are temporarily on hold, and the market may continue to return to the direction of short vol + long carry. A recent chat with peers joked, "This year's market, only trades for two days - non-farm payrolls and CPI, the rest of the time is in carry trade."

The Fed rate cut will have to wait, and the era of low interest rate currencies will have to wait a little longer.

Author: Fang Yuqi, Source: Morning Market, Original Title: "CPI and FOMC, Whom Do You Trust"