Inflation Loses Steam in the U.S.
Last week, eagerly anticipated inflation figures for October were released globally, including in the U.S. Both headline Consumer Price Index (CPI) and core CPI showed increases below expectations. Particularly, core CPI delivered a positive surprise in October. While no change was expected in core CPI, which stood at an annual rate of 4.1% and a monthly rate of 0.3% in September, the annual figure decreased to 4%, and the monthly core CPI was reported at 0.2%. On the headline side, the annual inflation remained at 3.2% (expectation was 3.3%), with no change in monthly inflation at 0.0% (expectation was 0.1%). The primary reason for the decline in inflation is the decrease in energy prices. Although the monthly changes in seasonally adjusted core inflation indicators are below those of the previous month, there is a slightly stronger trend in the short term compared to the trend before the rise in oil prices.
A day after the inflation figures, U.S. Producer Price Index (PPI) data was also released. Like the CPI, both headline and core PPI were reported below expectations on an annual and monthly basis. Following the dovish pricing after the inflation figures, the dollar index was at 103.6 when this article was written, and U.S. 10-year yields retreated to 4.43%. Gold is priced from 1980.
How Are Expectations Shaping Up for the FED?
After the inflation figures, the market is pricing in a 0% probability of an additional interest rate hike from the Federal Reserve (Fed). Currently, both December and January are priced at a 100% probability of being skipped, and the market is anticipating the first interest rate cut to be brought forward to May 2024. Some terminals even price in the first interest rate cut coming in March. Let me state this upfront: I believe the market has reacted excessively optimistically to U.S. inflation. Although there is a strong possibility that the Fed will not make an additional interest rate hike, I currently do not think it will start cutting rates so early. I believe the earliest possibility for the first interest rate cut is in June or July, which is stronger than current projections.
First Fed Interest Rate Cut Expected in May 2024
This week, U.S. markets will be closed on Thursday for the full day and on Friday for a half-day due to Thanksgiving. The most important focus for the U.S. this week will be the release of the Federal Open Market Committee (FOMC) minutes. The market will scrutinize the minutes to understand the views of Federal Reserve (Fed) members on the possibility of additional interest rate hikes. Particularly, attention will be paid to insights on whether Fed members believe that the high levels of the U.S. 10-year yields can substitute for further interest rate increases. My expectation is that even if the minutes turn out to be hawkish, it may not have a significant impact on market pricing. This is because, following the release of Consumer Price Index (CPI) and Producer Price Index (PPI) data, the market now believes that the Fed will not raise interest rates. Therefore, the market may perceive the minutes as outdated and irrelevant, considering that they pertain to a period before the inflation data. However, if the minutes reveal a more dovish tone, it could have an effect that further boosts risk appetite.
In the U.S. this Wednesday, we will receive durable goods orders, and on Friday, we will get manufacturing, services, and composite Purchasing Managers' Index (PMI) data. Going forward, positive (negative) economic indicators for economic growth in the U.S. could result in positive (negative) market pricing. Since good economic data is no longer seen as creating interest rate hike risks, positive economic indicators may be interpreted as strengthening the case for a soft landing, reducing the risk of a recession, and thus positively impacting market sentiment. Therefore, we will be monitoring whether such market pricing scenarios will come into play.
Pay Attention to Messages from Europe!
This week, numerous European Union (EU) members are scheduled to speak. In this context, both Christine Lagarde and one of the more hawkish members, Isabel Schnabel, will deliver speeches twice. Additionally, we will hear from Chief Economist Philip Lane and Vice President Luis de Guindos. Therefore, the messages in their speeches will be more crucial for the market than additional interest rate hikes (as the market no longer expects the European Central Bank (ECB) to raise interest rates further). Long-term high-interest rate narratives will be significant from the market perspective. On Thursday, both Eurozone-wide and country-specific manufacturing, services, and composite Purchasing Managers' Index (PMI) data will be released. Although a partial increase is expected compared to the previous month, the continuation of levels below 50, indicating economic contraction, is anticipated. If the PMI data confirms this trend, there may be downward pressure on the euro/dollar exchange rate.
Current Situation in Asia
On Monday, we observed that China did not change its 1-year and 5-year bond yields. This Friday, Japan's Consumer Price Index (CPI) figure is important. The expectation is for the core CPI to increase from 2.8% to 3%, maintaining inflation above the 2% target for the past 19 months.
