US Inflation Preview: Prepare for another elevated CPI report

Investors are bracing for another hot US inflation report that’ll embolden the Federal Reserve for another super-sized interest rate hike later this month. 

Consensus expects US inflation to accelerate to 8.8% year-on-year in June, up from 8.6% in May, which would mark the highest since December 1981.

Core inflation, which excludes volatile food and energy prices, is expected to ease to 5.7% year-on-year, down from 6.0% in May.

It’s all about expectations

The market hates uncertainty and right now, it's expecting inflation to come in at 8.8% and a 75 bps interest rate hike to follow shortly after.

CME’s Fedwatch Tool prices in a 92.4% probability of a 75 bps rate hike at the Fed’s July meeting.

Besides the numbers, it’s important to see a fall in sticky inflation factors (fuel, food and supply constraints), falling wage growth and easing consumer inflation expectations. 

What the market doesn’t want to see is another unexpected surprise in consumer prices, which would then rattle the recent narrative that inflation will soon peak and hopes of a more dovish Fed.

Interestingly, since the beginning of 2021, US month-on-month inflation prints have been above consensus expectations 11 times, and below expectation only once in August 2021, according to Bank of America.

So what does the market do when inflation surprises to the upside? It falls.

Notwithstanding other factors that may impact the S&P 500, the index has declined on every inflation print this year (except January).

S&P 500 performance on inflation print days (Source: TradingView)

What to expect this time

Goldman Sachs forecasts headline inflation to be above consensus tomorrow, at 8.88%. The investment bank's June CPI Preview said it expects shelter and retail inflation to slow, but auto prices to "likely rise meaningfully due to further global supply disruptions."

Elsewhere, Richmond Federal Reserve President Thomas Barkin said he expects inflation to come down but 'not immediately or predictably'.

Barkin cited early signals of easing freight costs and reports of a hiring slowdown. The pullback in commodity prices was also viewed as a factor that should help the inflation battle.

What to watch out for

The US inflation data will be released at 10:30 pm AEST.

Investors should watch how the Fed responds to tonight's inflation numbers, that being:

• Contempt with the numbers and hiking in-line with expectations; or

• Doing whatever it takes to bring inflation back to 2-3%

4 reasons for peak inflation

IHS Markit, now a part of S&P Global, provided four reasons why inflation will start to moderate - potentially substantially - in the second-half of 2022. 

1. Recent slowing of demand is greater than at any time during the pandemic (other than the initial lockdown) and not caused by pandemic lockdowns

2. Recent easing of price pressures associated with a “substantial moderation of supply chain delays”

3. Cooling of final demand accompanied by a shift away from inventory building, which will further reduce demand-pull pressure in input prices

4. Slowdown is seeing a steep pull-back in firms’ growth expectations. This drop in confidence will take pressure off labour demand and wages, weaken output growth in coming months, all of which relieves inflationary pressures

The main uncertainty is energy prices, especially in Europe, where prices have rocketed to all time highs due to uncertainty around Russian gas supplies.