Yesterday’s mix of economic data – which pointed at higher-than-expected inflation and lower-than-expected spending in the US – finally broke the Federal Reserve (Fed) doves’ and the equity bulls’ back for at least a day. US producer price inflation jumped to 0.6% on a monthly basis in February, and to 1.6% on a yearly basis.
Higher fuel and food prices were to blame. But even taking the volatile energy and food prices out, the core metric showed higher-than-expected price pressures last month, and core PPI remained steady at the 2% y-o-y. Retail sales, on the other hand, improved less than expected.
The data forced the market to reconsider the Fed's expectations. The probability of a June rate cut fell to 60%. The 2-year yield jumped to 4.70%, the 10-year yield spiked to 4.30%, the Dollar Index sharply rose and equities fell – though losses reversed toward the end of the session. The S&P 500 closed the session 0.29% down and Nasdaq fell 0.30%.
All eyes are on next week’s FOMC meeting. The Fed will update its dot plot having seen a two-month jump in inflation, robust jobs data, a relatively strong GDP print, and healthy earnings. There is a chance that we see the median forecast show no more than two rate cuts penciled in by the Fed members for the year – instead of three plotted at December’s dot plot. We will walk into next week’s FOMC meeting with a hawkish tilt knowing that it’s always better for the Fed not to act too early than to be forced to make a U-turn on the way.
Crude Extends Gains
US crude advanced to the $81pb level after Ukraine damaged 12% of Russia’s refining capacity with drone attacks. The IEA also gave support to the bulls yesterday by saying that they anticipate a supply deficit throughout this year if OPEC+ continues to cut output in Q2. This is a significant change in their forecast as they were pointing at a surplus in their earlier prediction. Trend and momentum indicators support a further rise in oil prices. But oil bulls could hit a wall if we see a hawkish shift from the Fed at next week’s meeting.
In the FX
The EUR/USD tumbled to 1.0873 on the back of a broadly stronger dollar and rising speculation that the European Central Bank (ECB) will cut the rates even if it’s not fully sure that inflation is headed to 2% target according to the Belgian central bank head Pierre Wunsch. The Governor of the Bank of Greece goes a step further and says that the ECB should cut rates twice before its August break.
However, let's return to reality. The ECB would find it challenging to act independently and implement numerous rate cuts if the Fed adopts a hawkish stance, leading to an appreciation of the US dollar. The ECB could take the risk of cutting before the Fed (in June) and announce one additional cut compared to the Fed at best before seeing inflation risks return to the bloc.
Price-wise, the EUR/USD outlook remains bearish. The pair will step into a medium-term bearish consolidation zone if it slips below the 1.0867 level – the major 38.2% Fibonacci retracement on the February – March rebound, and could extend gains all the way down to 1.06 in the continuation of an ABCD pattern.
Elsewhere, the USD/JPY is trending higher despite news that the wage negotiations in Japan show that big corporations meet the wage demand. Today, Rengo – the country’s biggest union group – will announce its numbers. Strong wage growth is inflationary and should convince the Bank of Japan (BoJ) to act sooner rather than later. However, the BoJ is expected to hold off until it obtains a clearer understanding of the wage landscape following the second and third rounds of negotiations, scheduled between the end of March and the beginning of April.
These negotiations will not only encompass major corporations but also extend to medium and small-sized companies. This being said, given the positive news from the early negotiations, it’s interesting to see that the Japanese yen bulls don’t hold a dominant position in the market this week. The USD/JPY is back above the 148 level. A broadly stronger US dollar certainly explains why the USD/JPY couldn’t gain a further downside momentum this week, but given how cheap the yen has become, I would expect the yen bulls to resist to the dollar’s upside pressure. They have not. Still, I think that going short the yen at the current levels doesn’t offer a potential worth taking the risk of a sizeable bullish run in the yen into next week’s BoJ decision.
And speaking of decisions, the PBoC left its MLF rate unchanged today, while home prices fell for a 13th month in China warning that all the efforts deployed so far couldn’t slow bleeding in the country’s problematic property sector.