Week Ahead: US PCE & NFP Keep the Fed in Focus, RBA Rate Decision, Eurozone CPI

Last week, U.S. equities closed higher, with the Dow Jones finishing up 0.23% for the week, while the S&P 500 settled 1.2% higher. Tech stocks helped the Nasdaq close up more than 2%. Meanwhile, the U.S. dollar booked a second straight week of gains.

However, the drama was seen in the bond market, with U.S. Treasury yields rising to fresh multi-decade highs after strong PMI data, amid elevated oil prices, rising inflation worries, and concerns over the US fiscal position.

U.S. PCE, Q2 GDP & Non-Farm Payrolls keep Fed rate hike expectations in focus

Heading into the new week, inflation, growth and Federal Reserve policy remain the primary macro themes. Investors will closely monitor bond yields, developments in the Iran talks and their impact on oil prices, as well as key data including core PCE, the Federal Reserve's preferred inflation gauge, Q2 GDP (Wednesday) and the non-farm payroll report on Friday.

Given that the Federal Reserve appears comfortable with the state of the U.S. labour market following the very strong August jobs report, it would likely take persistently weak employment data to materially alter Fed rate-hike expectations. Expectations are for around 100k jobs and unemployment to remain near 4.1%

Attention will therefore be more focused on the PCE figures for August. We have already seen the August CPI report, with headline inflation coming in as expected at 3.4%, while core inflation was hotter than forecast. Core PCE is forecast to rise to 3.4% from 3.3%.

Heading into the new week, the market is pricing in around a 70% probability that the Fed will hike rates in October. This is up from around 50% at the start of last week following stronger-than-expected PMI data. Fed speakers have largely been in the hawkish camp and have openly supported another rate move soon, while dovish policymakers have so far remained on the sidelines.

Hotter-than-expected inflation combined with stronger jobs data would further strengthen the case for another rate hike, potentially pushing Treasury yields and the dollar higher and pulling stock indices, such as the Dow Jones and precious metals lower.

RBA Rate Decision comes as AUD/USD nears 0.70

The RBA will announce its rate decision on September 29, with the central bank expected to raise interest rates by 25 basis points to 4.60%. Markets are pricing the move at a high probability following recent comments from Governor Michele Bullock and other policymakers.

The meeting comes amid persistent inflationary pressures, resilient labour demand and high energy costs, all of which strengthen the case for keeping policy restrictive. Inflation remains elevated, while unemployment is around 4.6%. At the same time, full-time employment growth has strengthened, although the housing market is showing signs of cooling.

The RBA is likely to emphasise that inflation risks remain to the upside and that policy needs to remain sufficiently restrictive to ensure inflation returns towards target.

The Australian dollar has had a challenging week, hit by poor risk sentiment and the global bond sell-off. Ongoing USD demand could challenge any AUD/USD recovery. However, stronger Australian rate expectations could provide support for the Australian dollar above the 200 EMA, particularly if the RBA delivers the expected hike and maintains a hawkish tone.

Will Eurozone Inflation help the EUR?

The preliminary September Eurozone inflation report will test whether higher energy prices are creating broader inflationary pressures.

August headline inflation rose to 3.3% year on year, while energy inflation jumped to 14.3%. Core inflation, however, eased to 2.4%.

If September CPI rises mainly due to energy inflation, policymakers could still treat the pressure as largely external. However, if core inflation also accelerates, the risk of second-round effects will be harder for the central bank to ignore.

For the euro, the reaction will likely depend less on the headline number and more on whether underlying inflation starts moving in the wrong direction.

EUR/USD is trading around a two-month low. While both the Fed and ECB have raised rates this month, the Eurozone economy remains considerably more fragile than the resilience seen in the U.S. This divergence has helped put the pair under significant pressure, with EUR/USD falling below 1.14.