Good morning. Front-end Treasury yields are slumping, equities are rallying, and the dollar is retreating after the Federal Reserve’s preferred inflation measure climbed by less than expected in August, making it more difficult to justify hiking rates in the months ahead.
Underlying price growth decelerated last month. Data released by the Bureau of Economic Analysis this morning showed the core personal consumption expenditures index rising 0.2% from the prior month, undershooting market forecasts for a 0.28% increase. On a year-over-year basis, core price growth slowed to 3.0% from 3.3% in July, well below the consensus 3.28% estimate. The overall personal consumption expenditures index climbed 0.3% relative to the prior month, and was up 3.4% from a year ago, below the expected 3.67%. Personal income rose 0.2% month-over-month, and inflation-adjusted household spending climbed 0.6%, missing and exceeding forecasts that had been set at 0.46% and 0.53%, respectively.
Yesterday’s newsflow also did little to justify market pricing for a rate hike at the Fed’s October meeting. Job openings fell more than expected in August, although hiring held up and layoffs remained low, pointing to a stable labour market. Consumer confidence slumped in September as inflation climbed, with households surveyed by the Conference Board expressing a degree of pessimism not seen during the 1970s oil shocks or in any crisis since. And New York Fed president John Williams pushed back against expectations of further tightening, saying: “With the policy action we took at our September meeting, there is no need for urgency, and we have time to gather more information”.
Global oil benchmarks are coming under pressure as supply recovers and diplomatic efforts continue. Flows through Saudi Arabia’s East-West pipeline are ramping up, helping overall crude exports from the Middle East approach 16mn barrels a day, the highest since the war began and not far off the prewar level of 19.5mn. At the same time, negotiators in Washington and Tehran are looking for an off-ramp ahead of the midterm elections, and the US is releasing supplies from its Strategic Petroleum Reserve in an effort to tamp prices down. Brent futures are trading at $103 a barrel, down 1.6% this week.
Against this backdrop, we think markets could begin to pare back expectations of tightening across the advanced economies in the months ahead*. Central bankers’ rhetoric aside, there is little evidence in any major trading bloc that higher energy prices are about to feed through to core inflation, while consumer demand is showing signs of softness that higher borrowing costs are compounding. If we’re right, the dollar might win the cleanest-dirty-shirt contest in the short run—as a more resilient growth foundation helps keep rates aloft for longer—but it too should eventually fall as interest differentials narrow.
The euro is trading on a firmer footing after inflation in France and Italy topped expectations, strengthening the case for further tightening from the European Central Bank. Updates this morning showed consumer prices rising 3.4% in France and 4.1% in Italy in the year to September as oil and natural-gas costs soared, while an earlier release saw Spanish inflation reach 5% over the same time frame, helping anchor expectations for Friday’s bloc-wide number higher. We don’t expect this to translate into an October hike, however: “We see higher inflation ahead but no signs yet that it is becoming embedded”, Christine Lagarde told the European Parliament yesterday. “This means that while the shock is too large to look through, we view a measured response as appropriate to keep inflation in check”.
A fault line in the core of the euro area is widening. With investors growing increasingly uneasy as French government spending outpaces tax receipts and political gridlock blocks any credible plan to rein in the deficit, the gap between French and German ten-year government bond yields has stretched to around 120 basis points, the widest since the 2012 euro crisis. France is now carrying the heaviest combined debt burden among major economies in the euro area—including both public and private borrowing—and traders are beginning to apply a small risk discount to the euro itself as they brace for ructions ahead.
The British pound is edging higher after revised figures showed the UK economy grew faster than first estimated in the second quarter. Gross domestic product was 1.4% higher than a year earlier, up from an initial estimate of 1.2%, the Office for National Statistics said, with output expanding 0.5% in the April-to-June period. Economists expect growth to slow in the second half as rising prices and heavier taxes squeeze consumers and businesses, adding to the drag from higher interest rates, and we think current market expectations—for at least four more rate hikes from the Bank of England by September next year—look vulnerable to revision.
The Canadian dollar was left unmoved yesterday when Statistics Canada said the economy stalled in July before recovering modestly in August. According to the release, output was flat in July and grew 0.2% in August, ahead of the latest tariffs, putting annualised third-quarter growth on track for 1.5% to 2%. Swaps traders are still pricing in a Bank of Canada rate hike by year-end, but that looks vulnerable given a wide output gap and scant evidence of spillovers from higher energy prices. Upcoming inflation numbers and the Bank’s own surveys could play a decisive role in shaping expectations across the front end of the curve—and in driving the exchange rate.
Admittedly, I’ve expected this for a while*, only to be wrongfooted repeatedly by central bank speeches.
**Broken clocks often outperform currency strategists.