The Stoxx 600 and the S&P 500 traded at a fresh YTD high on Monday as the British FTSE 100 lagged behind its Western peers, as mining stocks drove the index lower. But overall, 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 US 2-year yield advanced to 4.77% and the 10-year yield tested the 4.30% resistance, but both are down this morning, as bond investors lie in ambush before the US inflation update that will hit the headlines in a couple of hours from now.
All Eyes on US CPI
Headline CPI in the US is expected to have steadied on a monthly basis thanks to subdued energy prices and the yearly figure may have eased from 3.2% to 3.1% in November. Core inflation is seen steady at 4%. These numbers certainly look much better than what they did back in 2022, when we saw the US core inflation reach 6.6%. But at 4%, core inflation in the US is still twice the Federal Reserve’s (Fed) 2% policy target. And as the Fed Chair Powell will certainly say tomorrow, there is encouraging progress in the Fed’s fight against inflation, but the job is not done just yet.
But because the whole monetary policy tightening is here to fight inflation, a softer-than-expected set of inflation figures could further boost the Fed doves and appetite in US bonds, but gains will likely remain limited before tomorrow’s Fed decision and economic forecasts. Although the Fed is happy with the current results – weakening inflation despite a healthy loosening in the job market and quite resilient growth – Powell won’t cry victory on inflation and pop the champagne this week. If he did, the sovereign bond party would get out of control. The latter would send yields collapsing and loosen the financial conditions before time and interfere with the Fed’s plans to bring inflation down to 2%. Therefore, the chances are that the Fed will sound happy but cautious, no matter what we see in inflation print today.
Activity in Fed funds futures assesses 80% chance for a May rate cut and nearly 50% chance for a March rate cut. This week’s inflation data and Fed comments will shift these expectations toward one way or the other, but Powell will sure find it harder to control market optimism if headline inflation eased below the 3% psychological target, into the 2% waters, as yes, at 2 and something percent, we get really closer to the 2% target.
Calm Down, Says BoJ
The US dollar sees resistance near the top of its November-to-now downtrending channel, the EUR/USD waits around its 100-DMA to find a fresh direction, as the USD/JPY trades around the 145 level, having priced out a good number of expectations of an imminent rate hike next week, as the Bank of Japan (BoJ) officials already killed the idea that a rate hike will happen this month. But the BoJ will hike sooner rather than later, and that makes a short USD/JPY a good trade, for those who are patient enough. From now on, any price recoveries in the USD/JPY will be interesting opportunities to strengthen short USD/JPY positions for top sellers. Note that a stronger yen and a tighter monetary policy is not positive for stock valuations, therefore we could see the Japanese Nikkei 225 index drift lower as the hawkish BoJ expectations strengthen into next year.
In the energy space, US crude is gently recovering toward the $72pb level on threats that OPEC would extend and deepen cuts in case the selloff continued, but on the other hand, the industry news doesn’t help bring the bulls in. Freshly announced, Occidental (NYSE:OXY) agreed to buy CrownRock for about $10bn to extend its presence in the Permian Bassin. Consolidation in the Permian Basin means synergy, scale economies, and eventually lower production costs. The deal – which is set 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.