The US July inflation report, which showed a faster-than-expected slowdown in inflation, became the catalyst for a major rally in risk assets, especially in emerging markets. Investors took it as a factor that would ease pressure on the Fed to accelerate policy normalization. The key event today will be the release of the U. Michigan Consumer Sentiment report, which will likely point to an improvement in consumer sentiment due to a significant drop in gas prices in July. The risks in the report are skewed towards a positive surprise, so betting on a day of gains in equities and further strengthening of the dollar looks justified.
The PPI report released yesterday also signaled that price pressures in supply chains decreased in July, lending more heft to the idea that the consumer inflation trend has finally reversed. The monthly change in the producer price index was -0.5% with a forecast of 0.2%, core PPI rose by 0.2% with a forecast of 0.4%:
Today's report from U. Michigan is likely to indicate an increase in consumer sentiment (probably even higher than expected) due to the sharp decline in US gasoline prices last month (from $5 to $4 per gallon). The report will also contain fresh data on inflation expectations. They peaked at 3.1% earlier in the summer, declined to 2.9% in July and are expected to drop to 2.8% in August.
How will the market interpret the report? A pullback in inflation expectations appears to ease pressure on the Fed to hike rates quickly, but comments of the Fed policymakers this week attempted to convince markets that the high pace of tightening will continue despite positive data signals. Therefore, the market is likely to react only to a potential rebound in the consumer sentiment index, seeing it as a signal that the risks of a recession next year are decreasing, and, therefore, the Fed will proceed with loosening monetary policy later. Such a take on the report should also be dollar positive with the DXY probably challenging 105.50 level.