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Inflation pessimism casts a pall over the markets

inflation graph

Up until a week ago there was some optimism that we could be near a peak as far as US inflation is concerned.

That perception has taken a knock over the past few days, as reflected by a sharp rebound in yields, as central banks across the globe embark on a series of outsized rate hikes.

Last week the Bank of Canada hiked rates by 50bps, and this week the RBA followed suit with a similar move and signalled that more hikes were to come.

Yesterday the ECB signalled it would also be hiking rates starting next month with a 25bps move to be followed by a bigger move in September, and possibly October as well, if inflation continued to stay high. The ECB’s hawkish mood also caught bond markets on the hop sending yields spiking higher, and the Italian 10-year yield rising to its highest levels since November 2018, prompting concerns over fragmentation risk.

With the Federal Reserve also set to raise rates by 50bps next week, and at the next two meetings, there has been a significant shift in thinking when it comes to how quickly inflation is expected to return to target, with all the consequences that might have for any sort of economic growth this year.

The OECD didn’t help the mood this week with a gloomy assessment of the global economic outlook with a particular pessimistic focus on Europe and the UK.

With oil prices back at 3 months highs earlier this week and agricultural commodities also showing no signs of falling either, investors are quickly redoing their sums when it comes to earnings growth estimates, and they aren’t liking the numbers coming back.

European markets fell back for the third day in a row, while US markets also fell to their lowest levels this week, wiping out Tuesday’s strong rally, as nervousness started to creep in ahead of today’s US CPI report for May, with markets here in Europe set to open lower.

Over the last three months core PCE inflation has shown some signs it may have peaked falling from 5.2% to 4.9% in May. This was the second month in a row it had declined, having hit 5.3% back in February. Of course, no two inflation measures are alike, and PPI has remained resilient, while US CPI did show signs of slowing in April, it didn’t slow as much as had been expected.

Core prices slipped back to 6.2% from 6.6%, while headline prices fell to 8.3% from 8.5%. The increases in prices in other areas of the economy suggest that pricing pressures are much more widespread than just in food and energy, raising concerns that it may take a little longer to get inflation under control, with the one silver lining being that it didn't increase from March.

This stickiness is expected to prevail in today’s May numbers with headline inflation expected to remain unchanged at 8.3% while core prices are expected to come down from 6.2% to 5.9%.

We have started to see a decline in PPI in the last two months in a sign that pricing pressures are starting to slow at the coalface so to speak. Today’s CPI numbers could go some way to take some of the steam out of the selloff in the US bond market this week, but we’d need to see a move towards 8% for that to happen.

An increase in headline CPI is unlikely to be well received by equity markets, especially with the Federal Reserve rate meeting next week.  

EUR/USD – spiked briefly up to 1.0770 before sliding below 1.0630, potentially opening the prospect of a move towards 1.0530. We need to see a move above 1.0770 to target a move back towards 1.0820. 

GBP/USD – failed to move beyond the 1.2600 area earlier this week but remains above the 1.2450 area for now. A sustained break below 1.2450 argues for a move towards 1.2320. 

EUR/GBP – another failure at the 0.8600 area yesterday saw the euro slide back toward the key support area at 0.8470 area. A move below 0.8470 retargets the 0.8420 area.  

USD/JPY – still on course for a move towards the 2002 peaks at 135.00. We have intraday support at the 133.00 area. Only a move below the 50-day MA at 128.20 undermines upward momentum and argues for a move lower towards the 123.00 area.


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