US CPI (YoY) (JUN) (12:30 GMT; 08:30 ET)
Expected: 2.6%
Previous: 2.7%

US CPI Core (YoY) (JUN) (12:30 GMT; 08:30 ET)
Expected: 2.2%
Previous: 2.2%

How Will The Markets React?

Wednesday represents a huge day of event risk for US asset markets, as traders will face not only critical inflation data, but also Federal Reserve Chairman Ben Bernanke’s testimony before the House panel regarding monetary policy. Looking at the economic data on hand, the headline measure of CPI is anticipated to ease back to an annualized rate of 2.6 percent in June while core CPI is estimated to hold at a 13-month low of 2.2 percent. A reading in line with expectations is not likely to elicit much reaction from the markets, as traders will then wait for Bernanke’s testimony starting at 13:30 GMT. There is some speculation that the Federal Reserve Chairman will remain hawkish, and after the last FOMC statement said that “a sustained moderation in inflation pressures has yet to be convincingly demonstrated,” he will likely focus on the fact that core CPI is still uncomfortably high for the central bank. On the other hand, any sort of pick up in inflation readings will immediately lead the markets to consider that not only will rates surely stay on hold throughout the year, but that there is also a risk that they will be increased from current levels. Thus, the scenario tomorrow may have more to do with how hawkish the results are rather than if they will be hawkish at all. There is, of course, the outside chance that Bernanke will take a decidedly more neutral or dovish stance. Nevertheless, such a surprising action is highly unlikely and the risks for Fed inflation biases remain to the upside.

Bonds – US 10-Year Treasury Note Futures

Choppy price action in 10-year notes has prevailed over the past few weeks, but the contract made a clear move for a supporting trendline near 104-30/105-00 today. A close below there over the next day or two could spark a bearish move back toward the recent low at 103-21, and with hawkish rhetoric from Fed Chairman Bernanke potentially hitting the wires on Wednesday, Treasury declines may become a reality. However, if CPI is released at much softer-than-expected levels, 10-year notes could make a push for 106-00.

FX – EUR/USD

The tight consolidation of EUR/USD looks to be building up to a strong breakout, especially as the pair has not been able to penetrate the 1.3800 level. The only reason that this has gone on so long is that traders are anxiously awaiting a double dose of US event risk, as CPI and Fed Chairman Ben Bernanke’s testimony to the House panel will provide clues as to the central bank’s next policy move. Currently, EUR/USD looks very top heavy, with the greenback preparing to rebound. A move towards support near 1.3700 could easily become a reality if inflation does not ease in line with expectations, and if Bernanke maintains that core CPI has not fallen sufficiently. On the other hand, if CPI softens and the markets detect that the central bank may take a more neutral or dovish stance, the EUR/USD rally could continue and take aim on 1.3900.

Equities – S&P 500 Index

Despite the Dow's record close of 13,971.55, the Standard & Poor's 500 Index ended the day almost completely unchanged, down 0.15 to 1,549.37. Among the major S&P sectors, industrials, materials and technology led gains. In fact, the S&P materials index gained 0.6 percent, after paint and coatings makers Rohm and Haas Co. said late on Monday that its board of directors authorized the repurchase of up to $2 billion of its common shares. Rohm shares shot up 9.9 percent to $61.27. Meanwhile, American Express stock rose 4.6 percent to $64.74 following an upgrade by Goldman Sachs, which said American Express' network business was undervalued by the market.

Trading in consumer and banking stocks could be particularly rocky on Wednesday as key inflation data is due to be released. Signs that price pressures continue to persist will lead traders to consider the possibility of steady rates throughout the year, and perhaps even an eventual rate hike. Furthermore, hawkish data could be backed up by core inflation-focused commentary by Fed Chairman Bernanke, creating the perfect storm to send the S&P 500 plummeting from its recent highs near the 1,550 level, especially as the benchmark equity index has shown hesitance to break above 1,555. On the other hand, a sharp drop in CPI figures or overtly dovish commentary by Bernanke (note: this is very unlikely), could propel the S&P towards 1,600.

Terri Belkas is a Currency Strategist at FXCM.