Higher Now, Sharper Drop Later

June 13, 2024

Higher Now, Sharper Drop Later

  •  Fed officials signaled just one cut this year versus three previously. But Fed officials pencil-in bigger cuts in the next two years.
  • The US May PPI and Eurozone April industrial production data are today’s data highlights.
  • Australia’s May labor force report was good and will keep the RBA cautious from easing too early.

 

It was a wild ride in financial markets yesterday. The cooler-than-expected US May CPI print triggered an overshoot in US stocks and dragged Treasury yields and USD lower as Fed funds futures raised odds of 50bps of rate cuts in 2024 to 100% from 80%.

The moves were partly reversed after Fed officials signaled just one 25bps cut this year versus three previously. Treasury yields rose by roughly 10bps across the curve, USD retraced more than half its post-CPI plunge and Fed funds futures trimmed-back the probability of 50bps of cuts in 2024 to 86%.

Moreover, Fed Chair Jay Powell downplayed the immediate policy implications of the encouraging US May inflation reading pointing out vaguely “we need to see more good data to bolster inflation confidence”. Indeed, Fed officials raised headline and core PCE inflation projections for 2024 (+0.2pts to 2.6% and 2.8%, respectively) and 2025 (+0.1pts to 2.3% for both). According to Powell the new forecasts are “good but not great numbers”.

Overall, the Fed’s guidance that it plans to keep the funds rate higher for longer while other major central banks have started to cut rates is USD supportive. Nonetheless, Fed officials are looking to catch-up faster to the policy easing party in the next two years which can curtail USD strength. The Fed’s median rate-setter have penciled-in 100bps (vs. 75bps previously) of cuts in both 2025 and 2026. Of note, the longer-term Fed funds rate projection was raised 19bps to 2.75% implying less monetary restrictiveness than previously assumed.

Market activity should be more contained today. The US May PPI data is the highlight (1:30pm London). Both headline and core PPI are expected at 2.5% y/y vs. 2.2% and 2.4%, respectively in April. Watch-out for PPI ex-trade, transportation, and warehousing because it feeds into the core PCE calculations and rose to a cycle high 4.4% y/y in April. Later, New York Fed President John Williams moderates a discussion with Treasury Secretary Janet Yellen (5:00pm London).

GBP pared back gains against USD and EUR. The UK May RICS residential market survey points to softer housing market activity. The house price balance fell to a four-month low at -17 from -7 in April. There are no policy-relevant UK economic data releases today. On the political front, polls continue to give Labour over 20 points lead against the Tories.

EUR/USD is consolidating around 1.0800. French political uncertainty will likely remain a drag for EUR in the near-term due to heightened fiscal concerns. Polls suggest the French National Assembly could be even more divided following the upcoming legislative elections making it harder to get the fiscal house in order. Eurozone April industrial production is up next (10:00am London).

AUD/USD is trading heavy near the middle of its one month 0.6575-0.6700 range reflecting a firmer USD. Australia’s May labor force report was good and will keep the RBA cautious from easing too early. Employment increased 39.7k in May (consensus: 30k, prior 37.4k) driven by full-time jobs. In line with consensus, the unemployment rate dipped a tick to 4.0% on an unchanged participation rate of 66.8% and remains at the lower end of the RBA’s estimated full employment range of 4.0-5.75%. In our view, AUD can edge higher versus CAD because unlike the BOC the RBA is in no rush to cut rates.

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