Said Yellen, the job market’s cooling
Not faltering, but it’s stopped fueling
Inflation, and so
You all need to know
More rainbows are coming, no fooling!

Meanwhile, from the EU, Herr Knot
Was strangely less hawkish than thought
Inflation’s plateaued
Which opens the road
To starting a rate hike boycott

As we await today’s US Retail Sales data, and far more importantly, next week’s FOMC and ECB meetings, it seems that there is a concerted effort to talk inflation down by both the US and European governments.  For instance, yesterday, Treasury Secretary Yellen was explaining how, “the intensity of hiring demands on the part of firms has subsided.  The labor market’s cooling without there being any real distress associated with it.”  Now, I have no doubt that Secretary Yellen would dearly love that to be the case, although her proof on the subject remains scant.  Perhaps she is correct and that is the situation but given her track record regarding forecasting economic activity (abysmal while at the Fed and in her current role), I remain skeptical.  Certainly, while last month’s NFP data was slightly softer than forecast, it did not speak to a significant change in the labor market situation.

She proceeded to add how inflation was clearly coming down, although was careful to warn against reading too much into one month’s numbers, kind of like she was doing.  One thing she was not discussing was how the ongoing surge in deficit spending by the government, which she was personally overseeing, was having any impact on inflation.  Alas, history shows that there is a strong link between large deficits and rising inflation.  Maybe this time is different, but I doubt it.

But as I said, there seems to be a concerted effort to start to talk down inflation, especially as the efforts to actually address it are increasingly politically painful.  The next example comes from the Eurozone, where Klaas Knot, Dutch central bank chief and number one hawk on the ECB Governing Council suddenly changed his tune regarding a rate hike in September.  It was just a month ago, in the wake of the ECB’s last rate hike, when Madame Lagarde essentially promised a July hike, that he was on the tape explaining that a September hike was also critical and certain.  But now, his tone has changed dramatically, with comments like “[it] looks like core inflation has plateaued,” and he’s “optimistic to see inflation hitting 2% in 2024.”  

Again, maybe that outlook is correct and inflation in the Eurozone is going to come crashing down (remember, it is currently 5.4% on a core basis, far above the 2% target), but this also seems unlikely.  For instance, this morning’s headline, FRANCE TO RASE REGULATED ELECTRCITY PRICES BY 10%, would seem to be working against the idea that inflation is going to fall sharply.  In fact, one of the key reasons inflation ‘only’ rose as high as it did in the Eurozone, peaking at 10.6% last year, was that virtually every government subsidized skyrocketing energy prices for their citizens much to their national fiscal detriment.  Now that energy prices have come off the boil, they are ending those subsidies and hence, prices are rising to reflect the current reality.  So, the inflation they prevented last year will simply bleed into the statistics this year.

Politically, what makes inflation so difficult for governments is the fact that regardless of how they try to spin the situation, the population sees rising prices in their everyday lives and are unlikely to believe the spin.  However, that will not stop governments from doing their best to change attitudes via words rather than deeds.  Of course, given the prevailing Keynesian view that there is a direct tradeoff between employment and inflation, that puts politicians in a very difficult spot.  No politician is going to encourage rising unemployment just to get inflation down hence the ongoing attempts to jawbone inflation lower.  Ultimately, nothing has changed my view that inflation, as measured by CPI or PCE, is going to find a base in the 3.5%-4% area and be extremely difficult to push past those levels absent a catastrophic event.  And I certainly don’t wish for that!

But let’s take a look at how markets are responding to the renewed attempts to talk inflation lower, rather than actually push it lower.  Certainly, yesterday’s US equity performance showed no concerns over mundane issues like inflation as all 3 major indices continued to rally to new highs for the year.  Alas, there is less joy elsewhere in the world as Chinese stocks suffered along with most of Asia, although the Nikkei did eke out a small gain.  In Europe this morning, while the screen is virtually all red, the movements have been infinitesimal, on the order of -0.1% across the board.  And US futures at this hour (7:45) are showing similarly sized tiny declines.

The real news is in the bond market, which has taken this new government push to heart, and we now see yields falling across the board, in some cases quite sharply.  Treasury yields are down -4.5bps, but that pales in comparison to European sovereigns, all of which are lower by at least 7bps with Italian yields tumbling 12.5bps.  This newfound ECB dovishness is clearly a welcome relief for European governments, French electricity prices be damned.

In the commodity space, the base metals continue to signal a recession is on its way as both copper and aluminum continue to slide, but oil seems to have found a base for now, and is still higher on the month.  As to gold, it should be no surprise that it is rallying this morning, pushing back above $1960/oz as the combination of lower yields and a lower dollar are both tail winds for the barbarous relic.

Turning to the dollar, excluding the Turkish lira, which has tumbled 2.5% in anticipation of another underwhelming monetary policy response this week when the central bank meets, the rest of the EMG bloc is firmer, led by THB (+1.2%) on the combination of a broadly weaker dollar and hopes that the political stalemate in the wake of the recent election there is soon to be solved with a new candidate coming forward.  But the strength is broad-based across all 3 regions.  In the G10, NZD (-0.7%) is the only real laggard as market participants position themselves for tonight’s CPI release there with growing concerns that the central bank is not doing enough to support the currency and economy.  Otherwise, the bloc is generally firmer, albeit not dramatically so.

On the data front, Retail Sales (exp 0.5%, 0.3% ex autos) leads the way followed by IP (0.0%) and Capacity Utilization (79.5%) at 9:15.  There are still no Fed speakers, so while a big miss in Retail Sales could have an impact, I continue to expect that the equity earnings schedule is going to be the driving force in markets until the Fed meets next week.  So far, the first sets of numbers have been positive, but there is a long way to go.  

For now, the dollar remains on its heels, and I suspect that is where it will stay until next Wednesday at least.

Good luck
Adf