UPCOMING EVENTS:
Wednesday: US CPI
We finished the last week with a negative catalyst for risk coming from the US labour market report. The headline number surprised to the upside beating all forecasts, the unemployment rate fell, and the average hourly earnings increased. That’s what a “data-dependent” Fed absolutely doesn’t want to see, especially the increase in wages, and calls for another tough action on the rates front. The market odds of a 75 bps hike at the September meeting increased to 68% from the 40% before the release.
Besides the lagging labour market report, we also got the leading US ISM Manufacturing PMI which showed two major things: 1) the leading component “New Orders” fell even more into the contractionary territory to 48.0 versus the prior 49.2 and 2) prices paid saw the fourth largest decline on record coming at 60 from the prior 78.5. This just shows that tighter monetary conditions, decline in economic activity and the global slowdown are weighing both on demand and inflation, which is totally logical. I think there’s little doubt out there that inflation will ease in the next 6/12 months and the only issue is the rate at which it’s going to settle. The Fed’s target is 2% in Core PCE Y/Y, and they certainly want to see a meaningful fall to 3% at least before pausing or cut interest rates. This backward-looking approach, which is also what brought us to such high inflation, comes with the risk of overtightening in a recession.
This is all bad for risk and the market is already revising upward its terminal rate projections as new data shapes the future outlook. The USD gained on the release of the labour market report, and I expect it to continue to do so in light of a pushback in the “earlier than expected Fed Pivot” narrative that drove risk assets gains these past weeks. The next big test will be on Wednesday when the BLS will release the latest inflation report.
Headline CPI is expected to rise 0.3% M/M from the prior 1.3% and 8.9% Y/Y from the prior 9.1% (the estimates range from 0.0%-0.4% M/M and 8.5%-9.0% Y/Y). The relief in headline inflation is expected due to falling energy prices, with the sharp drop in gasoline leading the easing in prices. Food prices aren’t expected to have changed much. On the other hand, Core CPI is expected to increase further to 6.1% Y/Y from the prior 5.9% and the monthly rate ease a bit to 0.5% from the prior 0.7%. Needless to say, that an upside surprise across the board will provide much easier trades, leading to heavy risk off and the USD skyrocketing again. Things get murkier on a miss as peak inflation and “earlier Fed pivot” narratives may overshadow the Fed still tightening and the big hit coming to the economy.
This article was written by Giuseppe Dellamotta.
