US Dollar & Stocks on Edge. How to Trade this Risk Event?

• The U.S. Bureau of Labor Statistics will release March CPI data on Wednesday morning
• Another hot inflation report could shake the Fed’s monetary policy outlook, delaying rate cuts
• The U.S. dollar and stocks will be very sensitive to consumer price index results

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With inflation in the U.S. economy struggling to downshift this year, all eyes will be on the U.S. Bureau of Labor Statistics’ release of March CPI numbers on Wednesday. This report holds the potential to cause significant volatility across assets, so traders should prepare for the possibility of treacherous market conditions, especially if incoming data surprises to the upside.

In terms of estimates, headline CPI is forecast to have increased by 0.3% monthly, lifting the yearly reading to 3.4% from 3.2% previously. The core gauge, which excludes food and energy, is also expected to rise by 0.3% on a seasonally adjusted basis, though the 12-month rate is projected to ease to 3.7% from 3.8% prior, a small but welcome step in the right direction.

EVOLUTION OF US CPI

Source: BLS

UPCOMING US DATA

Source: DailyFX Economic Calendar

While Fed interest rate expectations have shifted in a more hawkish direction over the past few weeks on the back of hotter-than-anticipated CPI and employment figures, investors still see a greater than 50% chance that policymakers will ease their stance at the June meeting. This, however, could change if price pressures reaccelerate, bringing the disinflation progress to a screeching halt.

FOMC MEETING PROBABILITIES

Source: CME Group

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POTENTIAL SCENARIOS

The CPI report tops projections: Traders are likely to interpret this result as a sign that inflation is regaining momentum. This would dispel the notion that recent price spikes earlier in the year were temporary, reinforcing the likelihood of a longer battle to restore price stability. In response, the Fed could reassess its policy outlook, potentially delaying the start of its easing cycle. This scenario should be bullish for the U.S. dollar, but negative for risk assets such as equities.

Inflation numbers come below expectations: Markets are likely to celebrate this outcome, especially if the downside surprise is significant. This scenario could prompt traders to bolster their bets on the Fed initiating rate cuts in June, with the potential for at least 75 basis points of easing this year, in line with the central bank’s previous dot plot projections. A dovish repricing of interest rate expectations should weigh on Treasury yields, dragging down the U.S. dollar and boosting risk assets in the process.

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