Stock markets have picked up what New York put down and have declined in the wake of hotter-than-anticipated US inflation data and ahead of what should be an uneventful European Central Bank meeting.
London, Frankfurt and Paris are all in the red this morning albeit to varying degrees: the FTSE 100 is down 0.1 per cent, the Dax 0.4 per cent while the Cac is a touch away from flat. On Wall Street, both the Dow Jones industrial average and S&P 500 shed about 1 per cent; Asian shares followed suit.
US CPI inflation came in hotter than expected at 0.4 per cent month-on-month, sending traders to the exit bets on a June rate cut. Year-on-year rose to 3.5 per cent from 3.2 per cent, ahead of the 3.4 per cent expected. Core was up 0.4 per cent on the month, 3.8 per cent YoY. The headline three-month annualised rate jumped to 4.6 per cent (prior 4 per cent), with the six-month at 3.2 per cent. Core three-month annualised was rose to 4.5 per cent from 4.2 per cent, with the six-month steady at 3.9 per cent. Supercore was 0.7 per cent higher, or 5 per cent YoY.
Fundamentally, it’s as expected on the longer time frame – expectations and the reality are both totally unanchored and have been since the Federal Reserve said it would let inflation run hot in August 2020. It’s still trying to put the genie back in the bottle and markets are starting to question whether the next move may actually be to hike – the labour is still quite strong.
The data sparked sharp repricing in rates markets – the Treasury market had it worst day since the Kamikwaze Budget sparked turmoil in gilts. The 2-year jumped about 20bps, the most since the regional banking crisis a year ago. The 10-year yield has also risen more than 20bps since the data was released and traders have now priced out a June rate cut – just 16 per cent implied probability vs 60 per cent only a couple of weeks ago. That is a big shift from the start of the year – the last mile is proving the hardest. The boulder in the pond is creating ripples elsewhere. Market bets on the first 25bps rate cut from the Bank of England were pushed back from August to September.
Three months of surprising strong inflation is starting to look more like a sustained trend than a bump in the road. Question: what is the reaction function of the Fed in the face of this data? Everyone is talking like the data slams shut the door to a June cut…but what does the Fed think? Remember they revised up their core PCE forecast this year while sticking to three cuts…where do they think is neutral? We had always thought disinflation would be lumpy and 3 per cent is the new 2 per cent, but the question is whether this matters to the Fed.
Now it’s over to the European Central Bank decision today. Data since the March meeting has been mixed, but generally we see more slowing in inflation and growth than in the US, teeing up a possible divergence that FX traders were quick to jump on as EURUSD dipped and DXY hit its best since November. EZ core CPI inflation is annualizing at about 2 per cent vs 4 per cent in the US. I think they can confidently signal they are going to cut in June.
The Trader is written by Neil Wilson, chief market analyst at Finalto
