Yields are softening and the dollar is dropping ahead of US inflation numbers that could bolster the case for policy easing from the Federal Reserve. On a trade-weighted basis, the greenback is holding near a one-month low as most of its rivals advance.
Data out in less than half an hour is expected to show underlying US consumer prices rising at the slowest two-month pace since last summer, reinforcing market confidence in a rate cut at the Fed’s September meeting. The Bureau of Labor Statistics’ core inflation measure is seen climbing just 0.2 percent on a month-over-month basis, with goods costs continuing their decline while the core services component holds steady on stubbornly-elevated insurance and healthcare costs. This would come after a similar print in April.
Jerome Powell’s second turn at the mic in two days failed to deliver any new information on the likely pace and timing of rate cuts. In yesterday’s appearance before the House Financial Services Committee, the Fed chair repeated the messaging delivered in Tuesday’s testimony, saying “I do have some confidence” that inflation is slowing, but “The question is: Are we sufficiently confident that it is moving sustainably down to 2 percent? And I’m not prepared to say that yet”.
Politics loomed large once again. Republican Representative Mike Lawler attempted to challenge the Fed’s independence, asking if the central bank’s rate-setting committee saw that a “rate cut in September could be viewed as political just thirty to sixty days before an election?”. Powell rebutted this, saying “Our undertaking is to make decisions when and as they need to be made, based on the data, the incoming data, the evolving outlook and the balance of risks, and not in consideration of other factors, and that would include political factors”. “We have a long history of doing that, including during election years… It’s just not appropriate for us to get into the business of thinking about election cycles at all, one way or the other”. Democratic Representative Juan Vargas said, “You’re pretty boring here, to be frank,” and Powell responded “Thank you. That’s a high compliment.”
Our impression is that Powell is preparing the ground for a move in September – or at the very least, preserving the option to do so. By noting that incoming numbers have been positive, repeatedly using the word “yet” when discussing rate cuts, and forcefully pushing back against attempts to portray a September decision as politically-motivated, it seems likely the chair is readying investors and the broader public for a cut if “more good data” comes in. This isn’t triggering any turmoil in markets: two rate cuts have been priced into Fed Fund futures for 2024 since data began slowing last month.
The British economy grew twice as much as had been forecast in May, further reducing the likelihood of a rate cut at the Bank of England’s August meeting. According to the Office for National Statistics, output expanded 0.4 percent in the month, double the 0.2-percent consensus estimate, and up from zero in April. On a three month basis, the economy grew 0.9 percent, marking the fastest pace since January 2022, with a 1.1-percent growth rate in the services sector offsetting a flat trend in production, and a -0.7 contraction in construction.
Expectations for an easing cycle beginning in August were lowered yesterday after the central bank’s chief economist, Huw Pill, said rate cuts were coming, but warned that inflation might remain higher for longer than anticipated, making him less likely to vote for an early move. “In the absence of any big new shocks, the ‘when-rather-than-if’ characterisation of prospective Bank Rate cuts still seems appropriate,” Pill said in a speech. “It is hard to dispute the case that inflation persistence in the UK continues to prove – well – persistent. More data will come before we take our next policy decision at the MPC (Monetary Policy Committee) meeting on 1 August. But we have to be realistic about how much any one or two releases can add to our assessment”. Overnight index swaps suggest that odds on a cut are now sitting at coin-toss levels, down from circa 65-percent ahead of his remarks.
After reading our piece yesterday morning,* US President Joe Biden and Mexican President Andres Manuel Lopez Obrador said they would implement new policies to prevent the transshipment of steel and aluminium products through Mexico, cracking down on tariff evasion by companies based in China, Russia, Iran, and Belarus. Under the agreement, Mexican shipments into the United States will be subject to Section 232 (national security) tariffs if documentation is not provided showing where the metals were melted and poured, or smelt and cast. The peso exhibited no meaningful reaction to the announcement, but we think bilateral steps to reduce trade frictions could limit tail risk exposures on the margins, helping bolster the bull case for the currency in the near term. With recent currency weakness translating into upside inflation risks, the Banxico is likely to adopt a more cautious approach to easing policy in its next few meetings, meaning that wide rate differentials should continue to favour carry trade-related inflows during the typical summertime lull in overall currency volatility – at least, until a bigger shock hits.
Currency markets look remarkably complacent, with three-month implied volatility – a measure of expected changes in exchange rates – near the bottom of the range seen since 1990. To some extent, this is driven by the degree to which central bank expectations are moving in lockstep, but historical shocks have rarely come from changes in monetary policy itself – with global growth trajectories hitting turbulence, financial asset prices trading near all-time highs, and the geopolitical risk backdrop worsening, we suspect investors are under-appreciating the likelihood of a step-change in market conditions.
*This may be a gross mischaracterisation of the precipitating events.