Tripple Header Delight
- US May CPI data kicks off the action followed later in the day by the Fed’s decision and concludes with Powell’s presser.
- French political uncertainty is weighing on EUR and French bonds.
- UK economy stalls in April.
USD is holding on to most of its recent gains. 10-year Treasury yields dipped slightly on strong auction demand. S&P 500 and the Nasdaq reached new highs. Financial markets will take their cue today from the US May CPI report (1:30pm London), the Fed’s rate decision (7:00pm London) and Fed Chair Jay Powell’s press conference (7:30pm London).
US headline CPI is expected to rise 0.1% m/m versus 0.3% in April and remain steady at 3.4% y/y. Core CPI is projected to rise for a second consecutive month by 0.3% m/m and ease a tick to a three-year low of 3.5% y/y. The Cleveland Fed’s Nowcast model forecasts headline and core CPI at 3.36% and 3.55%, respectively. Pay particular attention to the super core CPI (core services less housing), a key factor behind the lack of progress on disinflation. In April, super core accelerated to 4.9% y/y in April, the highest since April 2023.
Sticky underlying US inflation will likely push USD and Treasury yields higher in the leadup to the Fed policy rate decision. In contrast, a soft US May CPI report can briefly weigh on USD and Treasury yields but turbocharge the rally in stocks.
Importantly, we expect the Fed to deliver a hawkish hold today which would bode well for USD and Treasury yields. The Fed is widely expected to keep the target range for the funds rate at 5.25-5.50% and reiterate it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent”.
We anticipate hawkish revisions to the Summary of Economic Projections. Past comments by Fed officials suggest the dot plot will likely be revised a little higher across the forecast horizon and indicate two 25bps cuts this year versus three previously. The risk is only one rate cut is pencilled in. Of note, Fed funds futures imply 80% probability of 50bps of cuts in 2024. Meanwhile, 2024 PCE inflation projection is expected to be raised slightly and the 2024 real GDP growth forecast will likely be trimmed reflecting recent data prints.
Fed Chair Jay Powell’s post meeting press conference will generate additional volatility particularly around his confidence assessment of the disinflation outlook. Following the May 1 FOMC meeting, Powell pointed out “so far this year, the data have not given us that greater confidence” that inflation is moving sustainably down to 2%. We anticipate Powell to stick to that script but acknowledge the mixed signals from the soft April PCE report and hot May average hourly earnings print. The risk is Powell throws a dovish curve ball.
EUR/USD remains under downside pressure around 1.0740 as Germany-France 10-year bond yield spreads widened sharply. French political uncertainty is weighing on French bonds and EUR due to heightened fiscal concerns.
France’s public deficit widened to 5.5% of GDP in 2023, more than the government's 4.9% of GDP target and significantly more than the European Commission’s (EC) 3% of GDP threshold. Budget deficits in excess of 3% of GDP tend to lead the EC to trigger excessive deficit procedure against member states.
French President Emmanuel Macron’s government was already struggling to pass budget-cutting legislation through the National Assembly as he lacks the necessary majority. By calling snap legislative elections on June 30 with a second round on July 7, Macron is hoping to get a mandate from the French people to deliver spending cuts and reign-in the budget deficit. As he put it “I have confidence in the French people to make the right choice now to enable the country to face the great challenges ahead of it”.
However, the strong result of France’s hard right National Rally (NR) party in the European Parliament elections suggests they could replicate this win in the French National Assembly. If so, parliament would be even more divided and getting the fiscal house in order would be extra complicated. The poor fiscal outlook prompt French Finance Minister Bruno Le Maire to warn “a debt crisis is possible in France, a Liz Truss scenario is possible”.
GBP/USD is firm near 1.2750. UK real GDP was flat in April after growing 0.4% m/m in March. The outcome was a little better than the 0.1% contraction expected, and the details were mixed. Services output was the main contributor with a growth of 0.19% despite the weather-related drag from wholesale and retail trade. Meanwhile, production output fell 0.11% and construction fell by 0.09%. In our view, the swaps market is under-pricing the likelihood of a Bank of England (BOE) policy rate cut in August (about 40% priced-in) which is a headwind for GBP. A 25bps cut is more than fully priced-in for November.
USD/JPY is trading in a tight range around 157.00. Japan PPI inflation quickened more than expected in May to 2.4% y/y (consensus: 2.0%) from 1.1% in April. This is an upside risk to inflation if businesses manage to pass on the input cost increases to consumers. Japan’s May CPI print is released next week.
China inflation cools more than expected in May. Annual headline CPI slowed to 0.3% (consensus: 0.4%) from 0.4% in April and core CPI (excluding food & energy) eased to 0.6% from 0.7% in April. The decline in PPI improved to 1.4% y/y (consensus: 1.5%) from 2.5% in April but producer prices have been stuck in deflation since October 2022. Overall, muted CPI inflation reflects weak domestic demand activity which remains a structural drag on the economy.
