The Stoxx 600 and the S&P500 traded at fresh yearly highs on Monday, while the UK’s FTSE 100 lagged its western peers as mining stocks dragged the index lower. Overall, however, the week started on an optimistic note ahead of today’s US inflation update, tomorrow’s FOMC decision and Thursday’s European Central Bank (ECB) and Bank of England (BoE) decisions. The U.S. 2-year yield rose to 4.77% and the 10-year yield tested 4.30% resistance, but both are down this morning as bond investors lie in wait ahead of the U.S. inflation update that will hit the headlines in a few hours.
All eyes on US CPI
US headline CPI is expected to have held steady on a monthly basis thanks to subdued energy prices, and the annual rate may have eased from 3.2% to 3.1% in November. Core inflation is seen holding steady at 4%. These numbers certainly look a lot better than they did in 2022, when we saw U.S. core inflation hit 6.6%. But at 4%, US core inflation is still double the Federal Reserve’s (Fed‘s) 2% target. And as Fed Chairman Powell is sure to say tomorrow, there has been encouraging progress in the Fed’s fight against inflation, but the job is not done.
But since the entire monetary tightening is here to fight inflation, a softer-than-expected set of inflation figures could further boost the Fed doves and the appetite for US bonds, but gains are likely to remain limited ahead of tomorrow’s Fed decision and economic forecasts. While the Fed is pleased with the current results – moderating inflation despite a healthy slack in the labor market and fairly robust growth – Powell won‘t be declaring victory on inflation and popping the champagne this week. If he did, the Treasury party would get out of hand. That would send yields tumbling, easing financial conditions prematurely and interfering with the Fed’s plans to get inflation down to 2%. Therefore, the odds are that the Fed will sound happy but cautious no matter what we see in today’s inflation print.
Activity in the Fed Funds futures market is pricing in an 80% chance of a May rate cut and almost a 50% chance of a March rate cut. This week’s inflation data and Fed comments will shift these expectations one way or the other, but Powell will surely find it harder to control market optimism if headline inflation eases below the psychological 3% target, into the 2% waters…because yes, at 2 and something percent, we are really getting closer to the 2% target.
Calm down, says the BoJ
The US Dollar finds resistance near the top of its November to now downtrending channel, the EURUSD is waiting around its 100 DMA to find a new direction, while the USDJPY is trading around the 145 level, having priced out a good number of expectations of an imminent rate hike next week, as Bank of Japan (BoJ) officials have already killed the idea of a rate hike this month. But the BoJ will hike sooner rather than later, and that makes short USDJPY a good trade for those who are patient enough. From now on, any rallies in the USDJPY will be interesting opportunities for top sellers to add to short USDJPY positions. Note that a stronger yen and tighter monetary policy are not positive for equity valuations, so we could see Japan’s Nikkei 225 index drift lower as hawkish BoJ expectations strengthen into next year.
In the energy space, US Crude is recovering slightly towards the $72pb level on the threat that OPEC would extend and deepen cuts if the selloff continues, but on the other hand, industry news isn’t helping to bring the bulls in. It was just announced that Occidental has agreed to buy CrownRock for about $10 billion to expand its presence in the Permian Basin. Consolidation in the Permian Bassin means synergies, economies of scale and ultimately lower production costs. The deal – which is expected to close in early 2024 – will help drive shale prices to levels not seen since the pandemic crushed oil markets, according to Bloomberg News. Just saying.
