All eyes on US inflation data today, could influence Fed decision
Dollar slips, sterling jumps after jobs data, stocks power higher
China cuts interest rates, crash in oil prices warns of soft demand
US inflation in focus
Global markets are about to encounter turbulence today with the release of the US CPI report for May. Economist forecasts suggest the headline and the core CPI rates are due to decline in yearly terms, mostly thanks to lower energy prices and base effects kicking in, as some very hot CPI prints from last year drop out of the 12-month calculation.
Market pricing currently implies around a 20% probability for the Fed to raise rates tomorrow, so either a ‘cold’ CPI release will send this number closer to zero or a ‘hot’ CPI will turn the Fed decision almost into a coin toss in the eyes of investors.
As for the reaction, a colder-than-expected inflation report might be a nightmare for the US dollar but a blessing for assets such as stocks and gold, which usually benefit from expectations of lower interest rates. A hotter-than-expected CPI could have the opposite effects, helping to boost the greenback while punishing equities and gold prices.
Dollar slips, sterling gains, stocks party
The dollar has been particularly unstable this week, when looking at smaller time-frames on the charts. Some of this volatility likely reflects hedging activity or positions being unwound ahead of this week’s risk events.
Sterling has been a star performer this entire year, capitalising on the euphoria in equity markets and a streak of encouraging data releases that have left the Bank of England no choice but to keep raising rates. This was also the case today, with the pound benefiting from the cheerful risk tone as well as incoming UK data revealing a booming labor market and intensifying wage pressures.
Stock markets are certainly trading as if the CPI has been leaked and was softer-than-expected. The Nasdaq gained another 1.5% yesterday and is on track to open higher again today, without any fresh catalysts behind the ascent. But the VIX also advanced yesterday, suggesting some caution has started to creep in.
Several elements lie behind the tremendous tech rally this year, including bets that central banks are about to pause rate hikes, global liquidity injections, and the mania surrounding artificial intelligence. The problem is that earnings growth is stagnant, valuations are stretched, and liquidity flows might turn negative this summer as the Treasury scrambles to replenish its cash levels.
China cuts rates, oil nurses losses
Some early signs suggest the US liquidity drain has already started, as there were two Treasury bond auctions yesterday that did not gather much demand, likely exerting downward pressure on bank reserves to absorb them. The Treasury will auction 30-year bonds today and if those are poorly received too, then the enthusiasm in riskier assets might lose some steam.
But while liquidity conditions are likely to tighten in the United States, they are loosening in China. The People’s Bank of China cut its repo rate to 1.9% from 2.0% previously, in an attempt to stimulate a slowing economy. Nonetheless the measures have been mild so far, which shows that Chinese authorities are not trying to flood the economy with stimulus, but rather to stabilise the situation.
Finally, oil prices fell sharply yesterday despite recent moves from Saudi Arabia to slash production and the US refilling its Strategic Petroleum Reserve. These bullish factors were likely overshadowed by demand concerns surrounding the Chinese economy and the risk that a deluge of supply could hit oil markets if the ongoing US-Iran negotiations bear fruit. 