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Markets Reset to Pre-Inflation Release Levels 

Yesterday’s inflation data failed to make a persuasive case for imminent rate cuts. Growth in both the headline and core consumer price measures declined more slowly than economists had hoped, and services ex-shelter inflation remained sticky, suggesting that the disinflation process could prove unexpectedly turbulent.

But markets are back to betting on rapid monetary easing. After a brief post-release bump, ten-year yields are back below the 4 percent threshold, Fed fund futures are discounting five or more cuts by the end of 2024, and odds on a 25-basis point move at the central bank’s March meeting are holding near 70 percent – effectively unchanged from pre-print levels.

In a less-than-helpful inflationary development, oil prices are sharply higher after the US and its allies launched airstrikes against Houthi rebels in Yemen, raising escalation risks. Both of the major global benchmarks – are up, with West Texas Intermediate trading around $75, and barrels of Brent going for more than $80. We should note that the airstrikes are unlikely to materially degrade rebel military capabilities – Saudi Arabia has attacked many of the same sites previously, and the US itself has hit Yemeni targets more than 350 times in the last two decades – meaning that the conflict could easily widen to include disrupting Iran’s command-and-control capabilities, and putting pressure on the regime itself.

Yet the disinflationary impulse coming from China remains historically strong. Data released last night showed the domestic consumer price index slipping -0.3 percent from already-depressed levels a year earlier, while factory-gate prices – which drive import costs for manufactured products across much of the global economy – fell -2.7 percent.

US producer prices are likely to exhibit corresponding dynamics, with this morning’s data expected to show costs rising just 0.1 percent in December from the prior month.

The British economy eked out a small gain in November, leaving a technical recession in play for the fourth quarter of 2023. Data out earlier this morning showed gross domestic product expanding 0.3 percent in November, offsetting a -0.3 percent contraction in October, and coming on the heels of a modestly-negative print in the third quarter. Expectations for Bank of England rate cuts remain effectively unchanged, and the pound is stuck clinging to the 1.27 mark against the dollar.

Currency markets more generally are dancing to a tune played on US equity bourses. With earnings reports beginning to trickle in below estimates, global risk appetite is falling, and sentiment-sensitive currencies like the Canadian dollar are retreating. This is unlikely to have lasting effects in the short term, but a more profound retracement is possible later in the year as US consumer demand fades and earnings expectations come down.

Note: Barring an unforeseen shock in global financial markets, we won’t publish on Monday in observance of Martin Luther King Jr. Day. We’ll return on Tuesday. Have a great weekend!

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