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Bulls Stampede Into Inflation Data

Market optimism is rising ahead of a key US inflation report that is expected to show price pressures softening on a sequential basis in April. Our summary of updated estimates provided by the biggest global banks and investment firms suggests that the headline basket is seen rising 0.4 percent month over month, bringing the annual change down to 3.4 percent from 3.5 percent in March. The core measure is believed to have climbed 0.3 percent, falling to 3.6 percent from 3.8 percent in the prior month.

Traders are positioning for an asymmetric market reaction. A strong print could be seen as a continuation of prevailing trends, with stable rate cut expectations keeping the dollar and Treasury yields roughly unchanged. In contrast, a broad-based relief rally might get underway if the print comes in below the consensus forecast, with equities surging and risk-sensitive currencies climbing against the dollar. With this outlook in mind, ten-year Treasury yields are holding near a five-week low, and the dollar is on the defensive as its major rivals outperform. Global stock markets are nearing record levels, and meme stocks are roaring higher.

But a single below-consensus print is unlikely to give policymakers the confidence needed to begin lowering rates. Data out in recent weeks has pointed to still-stubborn price pressures under the surface of the US economy, real income gains remain a powerful force supporting growth, and this morning’s retail sales data might highlight continued strength in consumer demand. In an appearance yesterday, Federal Reserve chair Jerome Powell said “It looks like it will take longer for us to become confident that inflation is coming down to 2 percent over time” so “we’ll need to be patient and let restrictive policy do its work”.

Current overnight index swap pricing suggests that all of the major central banks – with the exception of the Bank of Japan – will begin easing policy before the Fed does. A full rate cut is priced into curves for the European Central Bank in June, the Bank of Canada in July, and the Bank of England in August, with the US expected to follow at a lag in November. This could change drastically if US data begins to look more recessionary or – and especially if – global growth rates rise at the same time.

Among major currencies, the Japanese yen stands out as facing particularly convoluted event risks at this juncture. Odds on a rate hike by the central bank’s July meeting rocketed higher earlier this week after authorities reduced bond buying activity, and the currency has moved up in line with the decline in the dollar. Gains could extend if this morning’s US inflation data surprises to the downside. But rate differentials remain wide, and the “carry trade” – in which speculators borrow yen and invest in higher-yielding currencies – remains in rude health, and a stronger-than-expected rise in US prices might generate renewed selling pressure. When set against the still-present threat of currency intervention, the risk of extreme knee-jerk reactions looks elevated in the coming hours and days.

With markets awaiting another pivotal inflation report and pundits issuing a new set of confident predictions, it is worth noting that things have not played out as expected thus far this year. Year-ahead forecasts from December have fallen apart in a dramatic fashion, with the consensus getting both the scale and the direction of exchange rate moves spectacularly wrong. There is little to suggest that the latest round of projections – or the hyperbolic articles being published in the business press – will prove any more accurate. As always, it’s important to remember that consensus forecasts are embedded in prevailing spot rates, meaning that what moves currency markets in the future typically represents what isn’t currently foreseen.

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Twists & turns

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