It turns out inflation was higher
Though no one would call it on fire
The problem, alas
Is food, rent and gas
Show future results may be dire

But CPI’s yesterday’s news
Today it’s Christine and her views
Will she hike once more
Though growth’s on the floor
Or will, all the hawks, she refuse?

Yesterday’s CPI report could be termed luke-warm, I think, as the headline number was a tick higher than expected at 3.7%, while the core M/M number was also a tick higher than expected at 0.3%, although the Y/Y core number was right at the 4.3% expectation.  This provided fodder for both sides of the inflation discussion, with the inflationistas all claiming that higher CPI is coming, and we have bottomed while the deflationistas claimed that the results were insignificantly different from expectations and, oh yeah, rental prices are still falling so they are certain CPI will follow lower.  My go-to on this subject is always @inflation_guy and he explained (here) that some areas were hot and some not so much but does agree that any further declines in the CPI are likely to be quite small if they come at all.  I am in the camp that the new inflation level is somewhere in the 3.5%-4.0% area and short of a drastic recession, it will be extremely difficult to change that.

The stock market was certainly confused by the data as it initially sold off 0.5%, rebounded through most of the day only to see another late day decline and finish up very slightly higher overall.  In other words, it certainly doesn’t seem as though opinions were changed.  Treasury yields did edge a bit lower, falling 3bps, although this morning they have backed up by 1bp.  And the dollar finished the day net stronger vs. the G10, but actually net weaker vs. the EMG bloc.  All in all, I would argue we didn’t learn that much.

This brings us to today’s key story, the ECB meeting.  After the leaked story about the newest ECB forecasts calling for CPI above 3.0% next year, the market priced a greater probability of a hike today, it is still 65%, but net, have only one more hike priced in before the ECB is finished.  Madame Lagarde’s problem is that inflation is running hotter than in the US while their interest rate structure is 150bps lower and growth is very clearly rolling over.  The stickiness of European inflation has been quite evident and shows no signs of changing.  So what will she do?

Given Lagarde’s political background, as opposed to any central banking background, I expect that she will see the writing on the wall with respect to economic activity in the Eurozone, and if the ECB is going to be able to raise rates at all, this is probably the last chance.  By the October meeting, the European recession will be quite evident and her ability to hike rates then will be heavily circumscribed.  As such, I see 25bps today and that is the end, regardless of what her comments afterwards are.  

Trying to consider how the markets will react to this leads me to believe that European equities will soften a bit, although ahead of the meeting they are higher by about 0.3% across the board.  It also implies to me that we could see European sovereign yields creep higher (although right now they are lower by about 1bp across the board) as the inflation fighting stance alters before inflation retreats, and ultimately, I think the euro suffers as investors decide that there are better places to put their money.  In fact, I expect this opens the door for the next leg lower in the single currency, perhaps down to 1.05 before it finds a new ‘home’.

But wait, there’s more!  In fact, we have a plethora of data being released today in the US as follows:

Retail Sales	0.1%
-ex Autos	0.4%
Initial Claims	225K
Continuing Claims	1693K
PPI	0.4% (1.3% Y/Y)
-ex food & energy	0.2% (2.2% Y/Y)

Source: Bloomberg

For the market, and the Fed, I expect the Retail Sales number will be critical as last month we saw a very hot read, 0.7% while the market was looking for just 0.4%, and the ex Autos number was even hotter at 1.0%.  If we were to see another strong number here, especially if the Claims data continues to point to strength in the labor market, the Fed will certainly take note.  And while they may not hike next week, it would likely increase the odds of a November hike substantially.

Those are the key macro stories to watch today but there is one micro story that is worth noting and that is that the PBOC has been quite active recently in its efforts to prevent further renminbi weakness.  This morning they cut the reserve requirement ratio by a further 0.25% for banks in China and they also increased the issuance of bills offshore in Hong Kong thus pushing CNY rates higher there and pressuring those who would short the currency.  Finally, it appears that they have instructed several of the large state-owned banks to essentially intervene in the spot market at their direction, although the banks are the ones holding the risk.   So far, all their activity this week has pushed USDCNY lower by just 1.0%, so having some effect, but hardly reversing the longer-term trend weakness in the currency.  My take is, like the Japanese, they are more worried about the pace of any decline than the decline itself.  But in the end, unless we see some macro policy changes by either or both China and the US, the trend here remains for a weaker renminbi.

Ahead of the ECB meeting, markets have been quiet overall.  The dollar is mixed with an equal number of gainers and losers in both the G10 and EMG blocs and none of the movement more than 0.3%.  We have already discussed both stocks and bonds which leaves only commodities, which is the exception to the rule of limited movement today as oil (+1.5%) has jumped further with WTI pushing to just below $90/bbl.  While metals markets are mixed and little changed overall, the oil story is going to be a problem for both central bankers and politicians alike if the price continues to rise.  As we head into election season in the US, rising gasoline prices, and they are rising fast, will likely cause panic in the current administration.  Alas, they no longer have an SPR to offset the OPEC+ production cuts, they used that bullet, so the only hope for lower prices seems to be a dramatic decline in demand, and that will only occur if we have a deep recession, something else that politicians are desperate to avoid.  I remain bullish on oil overall, although we have seen a pretty big move over the past month, nearly 11%, so some consolidation wouldn’t be a big surprise.

And that’s really it for today.  At 8:15, the ECB releases its decision and statement.  At 8:30 the US data drops and then at 8:45 Madame Lagarde holds her press conference.  So, plenty to look forward to in the next hour or so.

Good luck

Adf