The latest release on inflation
Revealed, despite Powell’s fixation,
That prices have yet
To pose a real threat
So, look for more accommodation
Much to the Fed’s chagrin, yesterday’s inflation data was disappointing, with CPI rising just 1.8% in May, below both expectations and their target. Of course, they don’t target CPI, but PCE instead, however, history has shown that PCE typically runs about 0.3%-0.4% below CPI. Regardless of the statistic they view, what is abundantly clear is that price pressures, at least as measured by the both the Labor and Commerce departments, remain well below the level the Fed believes is consistent with a healthy economy. And it is this outcome which continues to animate the investment community.
If we ignore the comments from the White House and simply focus on the economic data, it is pretty easy to see why expectations of a rate cut are growing rapidly. The employment situation seems to have peaked and started to reverse, price pressures remain quiescent and every Q2 GDP forecast is for a pretty significant slowdown relative to Q1’s 3.1% rate. Given what appears to be a weakening trajectory in the US economy (not even considering the possibility of bigger issues driven by a full-blown trade war) and given that the Fed has implicitly assumed the responsibility to manage economic growth, a rate cut might seem pretty tempting at this point. While next week’s meeting seems quite aggressive for this line of thought, July, where the market is pricing in nearly a 100% probability, makes sense barring a sudden upturn in the data.
One of the things that has been weighing on the inflation data has been the sharp decline in oil prices over the past two months. Even with today’s 3.5% rally on the news of two oil tanker attacks in the Persian Gulf, WTI is lower by more than 20% since the third week of April. And the oil data continues to point to softening demand and growing supplies. Slowing global growth is sapping that demand, but producers continue to drill as quickly as possible. So, the central bank logic continues to be; lower interest rates will help sustain economic growth which will push up demand for energy (read oil prices) and help inflation get back to their comfort zone. Alas, that has been shown to be a pretty tenuous path for central banks to achieve their desired results and there is limited reason to believe it will work this time. In the end, it is becoming abundantly clear that we are about to embark on the next round of monetary ease, even in those nations which never tightened from the last round.
The difference this time is that markets do not seem to be embracing that as a panacea for all their troubles. While equity markets are modestly higher this morning, that follows two lackluster sessions with small losses. We continue to hear pundits highlighting a Fed cut as an important driver, but slowing global growth, especially the continued weakness in China, means that earnings estimates continue to slide and with them, expected equity gains. Add to this mix the unraveling of a few stories (Tesla, government pressure on tech companies) and suddenly the future is not so bright. We have also seen continued concern registered via the Treasury market, where 10-year yields have edged lower again today, trading at 2.11% as I type. While this is a few bps higher than the recent lows, it remains more than 50bps below where we started 2019 and the trend remains firmly downward. And rightly so if inflation is going to continue to decline.
The FX market has weighed all this evidence and remains…confused. While the dollar remains stronger overall in 2019, it has given back some of its gains during the past several weeks, at least against most G10 currencies. Today is a perfect example of the mixed view we’ve seen lately with the euro and the pound within 0.05% of yesterday’s closing levels, albeit the euro is higher and the pound lower. We see Aussie down 0.3% but CHF up 0.3%. You get the picture, there is little in the way of a trend. And quite frankly, that is likely to remain the case until we actually see the Fed (or ECB or BOJ or BOE) actually change policy. Broadly, there is little evidence that global growth is going to improve in the short run, and so FX movement is going to be based on the relative rate of weakness we see in economic data and the corresponding interest rate assumptions that will follow.
Looking at this morning’s data, we really only see Initial Claims (exp 216K), which is generally not a market mover. However, given the heightened sensitivity to the employment situation based on last Friday’s weak NFP report, any uptick here (above, say 230K) might have an outsized impact. Arguably, tonight’s Chinese data in Retail Sales and IP is likely to have a much bigger impact. And that’s really the day. Once again it looks like limited activity and correspondingly, limited movement in markets.