Uh oh! Yesterday’s inflation data from the US didn’t go smoothly down the market’s throat. Instead, the stronger-than-expected set of inflation data dashed hopes of seeing the Federal Reserve (Fed) cut rates anytime in the first half of this year.
The US 2-year yield jumped past 4.60% and returned to the levels before the Fed’s pivot hint in December – when they had revealed a dot plot predicting 75bp cut this year. The US 10-year is back to 4.30%. There is no way the Fed cuts its rates in March. The probability of a May rate cut tanked from 56% to around 40% in a single session. Markets now see the first Fed cut happen in June, with around 75% chance. That’s such a wild ride in market expectations; we began this year pricing 80% chance for a March rate cut, and we came all the way to pricing a 75% chance for a June rate cut.
No wonder, equities are not happy. The S&P 500 fell 1.37% yesterday from an ATH and Nasdaq dived 1.58%. Small caps, which are more sensitive to financing costs, tanked almost 4%. Although some insist that the data could be just a blip in the US disinflation trend and should not get everyone panicked and selling, the overbought market conditions which resulted from overstretched rate cut expectations should find a more balanced place to sit. It would only be healthy for the S&P 500 and Nasdaq to consolidate and give back some of the latest advance. Otherwise, the valuations become excessive and unsustainable, anyway.
Regarding the rate cuts, no one can tell you if June or July would be a better time for the Fed to start cutting. The data will decide when the time comes. Yet the incoming data shows a surprising strength in the US economy. Atlanta Fed’s GDP estimate, for example, prints a 3.4% growth for Q1 – far from a number that would push the Fed to start cutting rates. As such, the ‘blip’ in yesterday’s disinflation is more understandable than not given how strongly the US consumers spend.
The US Dollar Index rallied past its 100-DMA and tested the 105 level on the back of exhausted Fed doves. Gold slipped below $2000 per ounce on the back of a stronger dollar and rising yields – that increase the opportunity cost of holding the non-interest-bearing gold. The EUR/USD tested 1.07 to the downside, and the USD/JPY rallied past the 150 level. All eyes are now shifting to the Japanese officials who could – anytime – intervene in the FX markets to cool down the selling pressure on the yen.
Disinflation Continues Elsewhere
For those who didn’t have enough of inflation news, British inflation didn’t rise as expected in January despite a stronger-than-expected jobs data released yesterday. Cable remains under pressure due to a softer-than-expected CPI read and a broadly stronger dollar, but the selloff in EUR/GBP has potential to extend toward the 0.84 level in the continuation of an ABCD bearish pattern.
And finally, inflation in Switzerland got every single central banker envious as consumer prices in Switzerland rose only 1.3% in January on a yearly basis, down from 1.7% printed a month earlier. The super strong franc helped the Swiss keep their head above water this January – and even climb on a yacht! On a side note, I should admit that economists that put this number together have a better strategy for managing their health insurance costs (that went up by 10% this January on average) than I do, or the weight of insurance costs in the consumer basket doesn’t match the reality. But the good news is, the below-target inflation should encourage the Swiss National Bank (SNB) to cut rates before the others, soften the franc, boost the Swiss economy & exports, and help the SMI index return to the top half of its 2022-to-now trading range. But the bad news is, appetite for SMI will still face a challenging blow to overall investor sentiment if things start getting ugly elsewhere.