The Weekly Close Out

It’s been a tough week at the office for the greenback as the peak inflation narrative and consequently the less aggressive Fed creates the idea of a Goldilocks scenario, which is weighing on USD’s former bullish trend. The NY Fed’s survey of consumer inflation expectations got the ball rolling at the beginning of the week with the 5-year period showing a decline from 2.8% to 2.3%. However, wage pressures continue to remain sticky and show no signs of slowing as the unit labour costs report indicated on Tuesday with a print of 10.8% QoQ vs 9.5% expected. The main event globally this week was the US inflation data for July, which provided risk assets with a boost (VIX dropped below 20 level for first time since April 2021) and the dollar with the sell button. The market had become so used to upside surprises that this downside surprise was a bit of a shock. Headline printed at 8.5% YoY vs exp of 8.7% and the previous month of 9.1%. I think what also boosted sentiment was the miss on core too.

There was talk of a 100bps hike and potentially even an inter-meeting hike, but now that’s been quashed and even the near 80% chance of a 75bps hike has been scaled back with a 63.5% chance of a 50bps hike now on the cards. I would caution about waving the inflation victory flag just yet, as shelter & rent, general services and wage pressures remain very strong. The main factor cooling price pressures was the slump in energy prices, particularly gasoline. Used car, hotel and airfare prices also took some heat out of the numbers. Also, the Fed wants to see more than just one month’s worth of price pressures abating. To put it in perspective of how entrenched and elevated inflation is, if CPI prints at 0% MoM until the end of the year, inflation will still be at 6.2%.

Despite the dovish pivot and less aggressive rate path by the Fed being latched onto by the market, we got robust pushback from three FOMC members this week. The Fed’s Evans was first up as he stated that inflation was unacceptably high and that he expects rate hikes this year and next. He sees the fed funds rate at 3.25%-3.5% by the end of this year and 3.75%-4% by the end of 2023. That would mean an additional 100bps of hikes over the remaining three meetings (priced by the market).

Later in the session, President Kashkari (normally the most dovish member) reitared the trope that the Fed is far away from declaring victory on inflation and took rate expectations a step further, saying he saw a 3.9% fed funds rate by the end of this year and a 4.4% rate by the end of 2023. To hammer home the point on rate cuts, Kashkari called the idea of cuts early next year unrealistic and said the more realistic path was to raise rates and keep them there until inflation is well on its way to 2%. There is a big divergence between the market and the Fed’s expectation of where rates will be. One of those camps are wrong. Adding fuel to the inflation has peaked fire was the -0.5% PPI print for July (biggest drop since April 2020) and far below the 0.2% expected. Initial jobless claims were better than expected and the previous month’s number was revised lower. Still benefit claims are on an upward trajectory and needs to be observed regularly. Could today’s uMich consumer inflation expectations follow the NY Fed’s survey in showing a decline. The 5-year period is the most important for the Fed. This is a risk event for the market as the week comes to a close.

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