US Dollar: CPI outcome to steer Fed path – BBH

Brown Brothers Harriman’s (BBH) Elias Haddad notes the US Dollar (USD) weakened on broad Japanese Yen strength before partially recovering as strong US August payrolls revived expectations for a September Fed hike. Haddad stresses that United States (US) August Consumer Price Index (CPI) and Producer Price Index (PPI) will be pivotal for the Federal Reserve’s (Fed) next move and for USD direction, with balanced risks suggesting potentially volatile price action.

US inflation data to drive USD

"USD fell last week, largely reflecting broad JPY strength after markets briefly repriced a more hawkish Bank of Japan. USD recovered some ground on Friday. The solid US August nonfarm payrolls revived bets of a September Fed funds rate hike, which New York Fed President John Williams and Fed Governor Christopher Waller had earlier tempered by highlighting the encouraging inflation trend."

"A September 16 Fed funds rate hike hinges on Friday’s US August CPI print. Fed Chair Kevin Warsh noted in his August Jackson Hole speech that he welcomed this summer’s better than expected PCE and CPI readings but cautioned “they do not tell me that underlying trends have meaningfully improved.” As such, a hot CPI print would all but seal a September hike and underpin a firmer USD."

"More importantly, even if a September Fed hike becomes a done deal, we doubt USD will make new cyclical highs. Tightening by other major central banks limits policy divergence, with the ECB widely expected to deliver its second 25bps increase of the year on Thursday."

"Risks around the US August CPI print are finely balanced, setting the stage for an exceptionally volatile market reaction. The August pick-up in the ISM Prices Paid index suggests upside inflation risks have yet to recede. However, the continued slowdown in US average hourly earnings growth in August remains an important disinflationary force."

"The US August PPI (Thursday) will serve as a warmup act for Friday’s pivotal CPI report. Watch out for PPI Services less Trade, Transportation, and Warehousing as it partially feeds into the policy-relevant PCE calculation. Portfolio management fees could again distort PPI, although the BEA’s September 30 methodology change is poised to fix that."