US CPI (YoY) (SEP) (12:30 GMT; 08:30 ET)
Expected: 2.8%
Previous: 2.0%

US Core CPI (YoY) (SEP) (12:30 GMT; 08:30 ET)
Expected: 2.1%
Previous: 2.1%

How Will The Markets React?

With energy and food costs rocketing over the past two months, inflation pressures in the US have likely picked up significantly. As a result, headline CPI is estimated to risen an annualized 2.8 percent during September, the sharpest rise since March, while the core measure of consumer price growth is anticipated to have held steady at 2.1 percent. While the US Federal Reserve typically prefers to focus on the core CPI measure, a large jump in the headline reading will likely be worrying to the central bank. Furthermore, the pronounced weakness of the US dollar has caused concerns that import price inflation will be exacerbated by the currency’s movements. As Federal Reserve Chairman Ben Bernanke said recently, “One cannot deny that when the US dollar depreciates there is some inflationary impact.” On the other hand, St. Louis Federal Reserve President William Poole noted that he “did not see any evidence of a raft of US dollar price increases for foreign goods, with the exception obviously of commodities…But for manufactured goods…the pass-through is very, very small.” Nevertheless, there is a major risk that the September CPI readings, at least the headline figures, will actually prove to be stronger-than-expected, which will only exacerbate the sentiment that the Federal Reserve will not cut rates on October 31, as interest rate futures are only pricing in a 36 percent chance of a 25 basis point cut to 4.50 percent. However, if CPI proves to be much softer than expected, equity markets are likely to rally in anticipation of looser monetary policy.

Bonds – 10-Year Treasury Note Futures

Weakness in the US stock markets and support at the 108-13 level helped Treasuries gains on Tuesday, but tests of the day’s highs had limited follow-through, leaving the potential for a turn lower. If US CPI jumps in line with or exceeds expectations, Treasuries may indeed see a push down to 108-07, as signs that inflation is heating up could prevent the Federal Reserve from cutting rates on October 31.

FX – GBP/USD

The GBP/USD pair has done nothing but consolidate gains over the past two weeks, forming a flag formation on the daily charts and signaling the potential for a break higher. However, the release of US inflation data on Wednesday could spark a break lower, as CPI may prove to be stronger-than-expected, given the large increases seen in volatile food and energy costs during the month of September as well as the potential impact of the weak US dollar on import price growth. Traders may be feeling particularly jittery about the outlook for monetary policy by the Federal Reserve, especially ahead of the release of the bank’s October 31 rate decision. Interest rate futures currently price in a 36 percent chance of a 25 basis point cut, down from 88 percent just a few weeks ago. However, if CPI highlights that price pressures are mounting in the economy, it will become clear that the central bank really has very little room to make policy more accommodative and as a result, the data could lead GBP/USD to break lower for a test of 2.0190.

Equities – Dow Jones Industrial Average

US equities continued to make their way lower on Tuesday as oil prices rocketed to fresh intraday highs. The daily charts of the Dow Jones Industrial Average show that the index may be heading for support at the confluence of the 100 SMA and the 38.2 percent Fib of 12,517.94 – 14,198.10 at 13,551/55, especially as MACD shows a bearish divergence. The release of US CPI in line with or greater than expectations could exacerbate the move lower, as signs that inflation is heating up could prevent the Federal Reserve from cutting rates on October 31.

Terri Belkas is a Currency Strategist at FXCM.