Week Ahead: US CPI, ECB Rate Decision, Japan GDP

U.S. equities finished the week mixed, with the Dow Jones down 0.3%, the Nasdaq up 0.4%, while the S&P 500 gained 0.1% across the week. At the same time, the U.S. dollar finished the week lower.

These moves came as the outlook for Federal Reserve interest rates remains the primary issue. August nonfarm payrolls smashed expectations, surging by 162,000 versus forecasts of 56,000, whilst the unemployment rate remained unchanged at 4.1% and wage growth slowed to 3.1%.

Heading into the new week, Fed funds point to a 57% chance of a September rate hike.

US PPI, CPI

Attention will be firmly on U.S. inflation for further clues over the Fed's next move.

The data comes as developments in the Middle East have deteriorated in recent weeks, lifting oil prices higher. Fresh military operations from both the U.S. and Iran, and limited transit through the Strait of Hormuz, are keeping supply concerns front and centre.

High oil prices have ramped up inflation expectations, fuelling Fed rate hike bets and pushing sovereign bond yields higher. U.S. yields are at critical levels for risk appetite.

U.S. PPI, or wholesale inflation, will be released on Thursday and is expected to remain elevated after reaching 4.7% in July. On a monthly basis, PPI is expected to rise 0.3%, up from 0.2% in July.

U.S. CPI data will also be released and is expected to hold steady at 3.4%. However, on a monthly basis, expectations are for a 0.4% increase, up from 0.1% in August.

With the market assigning a 57% probability of a 25-basis-point rate hike next week, down from 70% at the start of the month, a strong CPI figure could further raise rate hike expectations, lifting the USD while weighing on stocks and gold.

A cooler-than-expected CPI print could be more market-moving, particularly following the strong NFP report and dovish comments from Fed Governor Waller last week. A cooler report could pull the USD and Treasury yields lower and boost gold and stocks, with the S&P 500 trading in a possible bull flag pattern.

ECB rate decision – how hawkish will the hike be?

The ECB is widely expected to raise interest rates by 25 basis points on September 10, taking the deposit rate to 2.5%, as surging energy prices push inflation further above the ECB's 2% target.

Eurozone inflation accelerated to 3.3%, up from 2.9% in July. Core inflation declined to 2.4% from 2.5%, whilst energy inflation jumped to 14.3% from 10.3%.

The meeting comes against a backdrop of turmoil in global bond markets, as renewed hostilities between the U.S. and Iran lift oil prices and fuel inflation concerns. President Christine Lagarde's press conference will likely offer valuable insight into December's meeting, particularly surrounding the size of second-round effects from inflation, which could validate the 80% probability attached to another rate hike before the end of the year.

Should the ECB deliver a hawkish hike, which, if combined with softer U.S. data, could help move EUR/USD towards 1.17. However, persistent U.S. dollar strength and a more cautious-sounding ECB could see EUR/USD fall towards 1.15.

Japanese Labor Earnings & Q2 GDP

After suspected intervention by Japanese authorities to support the yen last week, attention will be firmly on Japanese economic data ahead of the U.S. inflation report on Friday.

Japanese labour cash earnings are expected to rise to 3.9% year-on-year in July, up from 3.4%. GDP is expected to show growth of 0.4% quarter-on-quarter in Q2, up from 0.3% in Q1, with an annualised rate of 1.1%.

Stronger data could further support expectations of a BoJ rate hike this month, which are already around 80%, and help support the yen further, particularly if combined with a weaker U.S. CPI reading on Friday.

However, weaker Japanese data combined with a stronger-than-expected U.S. CPI could see the yen retreat and USD/JPY move away from the 155.20 support level.

As the market focuses more on the timing of the next BoJ hike, domestic data is becoming more important for the yen. Stronger Japanese growth and wages, paired with softer U.S. inflation, would strengthen the case for further yen gains, while the opposite outcome could see USD/JPY recover.