The CPI data was warm
But not warm enough to deform
The view that the Fed
Was moving ahead
With rate cuts which are the new norm
 
While fifty seems out for next week
Investors, by year end, still seek
A full percent cut
Just when, though, is what
Defines why we need Jay to speak

 

It turns out that core CPI printed a tick higher than expected on the monthly result, although the Y/Y number was right in line with most forecasts.  In the broad scheme of things, it is not clear to me that a 0.1% difference in one month matters all that much, but markets are virtually designed to overreact to ‘surprising’ data.  At least, the algorithms that drive so much trading are designed to do so, or so it seems.  However, as can be seen by the chart below, it was a pretty short-lived dip and then the march higher in equity prices continued.

Source: tradingeconomics.com

While Fed funds futures pricing has adjusted the probability of a 50bp cut next week by the Fed down to just 15%, that market is still pricing in 100bps of cuts by the December meeting which means that there needs to be a 50bp cut in either November or December as they are the only two meetings left after next week.  As @inflation_guy highlighted in his always perceptive writeups on the CPI report, yesterday’s number ought not have changed the Fed’s thinking.  And perhaps that is exactly what we saw from the equity market, the realization that 50bps is still on the table for next week, especially since there is a growing feeling that’s what Powell wants to do.  I’m confident if Powell pushes for 50bps, he will have no trouble gaining quick acceptance around the table.

Ultimately, I think the problem with focusing on CPI is that the Fed doesn’t focus on CPI, even when they are worried about inflation.  However, especially now that they seem to believe they have achieved victory in that part of their mandate, it strikes me that the numbers about which they really care are the employment numbers.  Last week’s NFP report was mixed at best, although the actual NFP data was the weakest part of the report.  This morning, we get the weekly Claims data (exp Initial 230K, Continuing 1850K), but those numbers have been very stable of late, and not pointing to serious difficulties at all.  To my eye, from the perspective of the economic data that we continue to see, there is limited reason for the Fed to cut at all, especially with inflation still well above their target, but Powell promised a cut, and we have seen nothing since his Jackson Hole speech that could have changed view.  

A better question is, are they really going to cut 250bps by the end of 2025?  That would imply, at least to me, that the economy has slowed substantially, and likely headed into recession.  And, if the data turns recessionary, I can assure you that the Fed will have cut far more than 250bps by the end of next year, probably more like 350bps-400bps.  My point is I cannot look at the market pricing of interest rates and make it fit with the economic outlook at this time.  What I can do, however, is feel confident that if the Fed starts to cut rates aggressively with economic activity at current levels (remember, the GDPNow forecast is at 2.5% for Q3), inflation is likely to pick back up more quickly than people anticipate and the dollar, and bond market, will suffer while commodities and gold rise.

In the meantime, in a short while we will hear from Madame Lagarde as she follows up the almost certain 25bp rate cut they will declare today with her press conference.  I would argue the bigger news out of Europe is the ongoing discussion about increasing Eurozone debt issuance, as suggested by Mario (whatever it takes) Draghi in his report I discussed on Monday.  A look at the recent data from the continent shows that Unemployment is currently at historic lows for Europe, although that is still 6.4%, and inflation has fallen to 2.2%, just barely above their 2.0% target.  As such, here too it seems that the data is not screaming out for action.  Now, the punditry is looking for a so-called hawkish cut, one where the commentary does not discuss future cuts as a given, and I think that would be a sensible outcome.  But not dissimilar to the US situation, where a key driver of rate cut desires is the governments who are the biggest borrowers, there is intense political pressure to cut rates and reduce interest expense.  In fact, I believe that is a key reason behind Draghi’s report, to gain support and remove some of that direct interest rate expense from certain countries’ cost structure.  Thinking it through, net this should benefit the euro in the FX market as the Fed seems hell-bent on cutting and the ECB a bit less so.  We shall see,

Ok, so let’s turn to the overnight sessions to see where things are now.  After the US rebounded yesterday afternoon on the back of strength in the tech sector, we saw a huge rally in Tokyo (Nikkei +3.4%) on the same premise.  And while the Hang Seng (+0.8%) had a good session, once again, mainland Chinese shares (CSI 300 -0.4%) did not participate.  In fact, most of Asia was in the green, once again highlighting the weakness in the Chinese market, and the perception of that weakness in the Chinese economy.  As to Europe, it too has seen strength everywhere with gains between 0.8% (FTSE 100, CAC) and 1.20% (DAX).  This story is one of following the US, hopes for a bit more dovishness from the ECB, and a growing story about the potential for bank mergers in Europe with news that Italy’s UniCredit Bank has taken a stake in, and is considering buying, Germany’s Commezbank.  As to the US futures market, at this hour (7:20) they are all very modestly in the green.

In the bond markets, yields continue to back up slowly from the lows seen earlier this week with both Treasury (+2bps) and most European sovereign (Bunds +2bps, Gilts +2bps, OATs +1bp) slightly higher this morning.  Overnight, we saw JGB yields tick up only 1bp despite a relatively hawkish speech from BOJ member Naoki Tamura.  He indicated that rates should be raised to 1.0% by the end of their current forecast cycle, which sounds like a lot until you realize that is the end of 2027!  Maybe the 1bp move is appropriate after all.

In the commodity markets, oil (+1.7%) is continuing yesterday’s rally as questions about how quickly Gulf of Mexico production will restart in the wake of Hurricane Francine are driving markets.  While the weak demand story still has proponents, the reality is that oil prices have fallen more than 12% in the past month, a pretty large decline overall, so a bounce cannot be surprising.  In the metals markets, after a solid session yesterday, metals prices are higher in both the precious and industrial spaces.

Finally, the dollar is doing very little this morning, but if forced to define the move, it would be slightly softer.  While most currencies in both the G10 and EMG blocs are just a touch firmer, between 0.1% and 0.2%, the biggest mover, ironically is a decline, ZAR (-0.4%), although other than short term trading and positioning, there doesn’t seem to be a clear catalyst for the decline.

On the data front, in addition to the Claims data noted above, we see PPI (exp headline 0.1% M/M, 1.8% Y/Y; core 0.2% M/M, 2.5% Y/Y). Of course, there are no Fed speakers, but after the ECB announcement and press conference, we will hear from some ECB speakers as well.  Right now, the dichotomy between what the bond market is expecting (much lower rates anticipating weaker economic activity) and the stock market is expecting (ever higher earnings growth amid economic strength) remains wide.  While there are decent arguments on both sides, my sense is the bond market is more likely correct than the stock market.  And that is probably a dollar negative, at least at first.

Good luck

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