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Will US CPI give markets a reality check?


Optimism over today’s US inflation numbers has helped drive a positive start to 2023 for both European and US markets so far this year, with the Nasdaq 100 closing higher for the fourth day in a row.

Sentiment in Europe has also been helped by the recent milder weather which has fuelled optimism that the start of 2023 might offer some respite from further increases in energy prices, and this optimism looks set to continue today with another positive open.

The way US markets have been behaving over the past few days today’s US CPI numbers are merely the next waypoint to a pivot sometime later this year, as the disconnect between what the Fed would like the markets to think, and what the market is pricing continues to grow ever wider. 

From Friday’s ISM services report to the fall in average hourly earnings, investors appear to have decided that the Fed will only raises rates by 25bps on the 1st February despite the continuing efforts of Fed officials to push back on that narrative.

Several US policymakers have gone to great lengths in the past few days to state that rates are heading over 5% and set to stay there, yet the US 2-year yield still firmly remains below the upper bound of the Fed Funds rate of 4.5%.

In a way it’s not hard to understand why the markets believe a pivot might be coming given how headline CPI has consistently fallen back from the peaks of 9.1% seen in June. In November we came in at 7.1% which was well below expectations of 7.3% and a sharp fall from October’s 7.7%, offering a boost to those who think that the Federal Reserve may not have to go as hard, or as far on rate hikes this year.

The belief that a pivot is coming may also have something to do with the dire predictions of the likes of the IMF last week, and earlier this week by the World Bank, who both warned the global economy was on a razors edge, and at risk of sliding into a prolonged recession

Nonetheless it’s a dangerous conclusion to draw with the main focus set to be on core inflation, and whether it continues to come in lower, in the same way it did in November slipping from 6.3% to 6%, given concerns about the sticky nature of underlying prices. This is where it could all unravel as far as the recent narrative given that the expectation is for core prices to slide to their lowest levels since December 2021 at 5.7%.

If core prices were to come in higher than expected we could see a sharp correction lower for stocks and a sharp rebound in the US dollar, and a shift in focus back to 50bps in February.

It’s also important to remember, as was the case in Australia yesterday, that inflation doesn’t fall in a straight line, after annual CPI there jumped more than expected from 6.9% in October to 7.3% in November, which in turn could prompt the RBA to be more hawkish next month after they slowed the pace of their rate hikes two months ago.

This is what should concern Fed officials the most, and what markets appear to be forgetting in their pricing of the Fed’s next move.

It’s also important to remember given how markets front run any indication of a shift in policy, that Fed officials might look to err more towards doing too much than too little, and as such might be tempted to overtighten in order to get inflation falling sustainability towards the 2% target.

EUR/USD – continues to edge closer to the June highs at 1.0787. This remains the key barrier when it comes to further gains, after last week’s reversal off 3-week lows at 1.0480/85.  A move through 1.0800 has the potential to open a move towards 1. 0920.

GBP/USD – continues to slip back from the 1.2200 area, after last week’s rebound from 6-week lows at 1.1830/35.  The next big resistance lies at the 1.2350 area. We need to hold above the 1.2000 area for further gains to unfold.

EUR/GBP – tried and failed to push through the 0.8870/80 yesterday before slipping back. This remains resistance and has contained rallies since October last year. Support remains at the lows this week at 0.8770/80 area. A move below 0.8770 opens up a move back to the 50-day SMA at 0.8700.

USD/JPY – while below the highs of last week at 134.80 the bias remains for a return to the recent lows at 129.50, where we saw the US dollar bounce from a 6-month low. Above 135.00 targets a move towards 138.00.


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