US inflation to highlight tighter real policy

USD: Falling inflation and tighter Fed policy

A Japan holiday, Chinese New Year and limited data flow all contributed to the relatively quiet start to the week yesterday with DXY trading within a 40 pip range. The US dollar did drift a little higher as US yields nudged higher relative to yields in Europe. Today brings the key data of the week – the US CPI but it’s hard to see the rhetoric from the Fed shifting much given the consistency of the message that more time is required before cuts can commence. It would take a much bigger drop for the market to anticipate a shift in Fed thinking. The danger must be that the Fed remain cautious which ultimately will result in the monetary stance of the Fed becoming tighter and tighter in real terms. That implies increased risks of policy becoming excessively tight which could reinforce slowing economic growth and threaten the ongoing resilience of equity market performance. The latest equity market performance with the S&P 500 breaking above the 5,000 mark for the first time has seen the forward P/E breaking back above the 20-level. Equities are again in very expensive territory based on forward P/E that could prompt bigger downside moves on any bad news ahead.

The disinflation trend remains pretty compelling and even an upside surprise in the CPI data today is unlikely to alter the clear trend in place. The New York Fed yesterday released its inflation expectations data and the 3yr inflation expectations reading fell to 2.35% in January, the lowest level on record in data going back nearly eleven years. Food and rents are two key components in shaping expectations and food inflation expectations 12mths ahead fell to 4.9%, the lowest since March 2020 while rent inflation expectations fell to the lowest level since late 2020.

The core CPI MoM rate is expected to remain at 0.3% in today’s data with the annual rate falling to 3.7%. The supercore CPI levels (core services, ex-housing) will also be important with the MoM increase in December at 0.34% and 0.44% in November. The 3 and 6mth annualised rates remain above 4.0% and some further slowdown will be required in order for the optimism over sustained disinflation to be maintained. Still, rental disinflation is an important element of potential good news ahead and should be evident in today’s data as well.

A good inflation print today will likely be enough to halt the move higher in short-term yields but it would take a substantially weaker CPI print to prompt a deeper plunge in yields that would drag the dollar weaker. A March rate cut looks like a lost cause now but a very weak CPI print will see May very much back in play. But with the ECB still not dismissing an April cut completely we see limited scope for dollar weakness. A strong CPI print looks more likely to prompt a bigger dollar move to the upside as a May cut would be put in further doubt.

S&P 500 P/E UNDERLINES ELEVATED EQUITY VALUATIONS

Source: Bloomberg, Macrobond & MUFG GMR

GBP: Wage growth resilience but signs of weakness emerging

The pound is likely to derive support from the jobs data released just now this morning. The focus of the BoE is very much on two aspects of upside risks to achieving price stability over the medium-term. The first is services inflation, which remains well north of 6.0% and the second is wage growth which until today was also well north of 6.0%. The December wage data today did reveal a slowdown but from an upwardly revised November level (6.7% from 6.5%) and the headline December level was also 0.2ppt stronger than expected at 5.8%. Excluding bonuses, the underlying wage growth rate remained above 6.0% at 6.2%. So net-net, the wage data were again stronger than expected and will encourage continued caution by the BoE over signalling the potential for rate cuts.

The jobs data also were stronger. The 3mth/3mth change in employment increased 72k, stronger than expected while the ILO unemployment rate fell to 3.8%, the lowest level since January 2023. The more advanced PAYE jobs data for January showed an increased of 48k with a big upward revision to the December estimate (55k upward revision to 31k) while the PAYE wage data also rebounded sharply on a 6mth annualised basis to back above 6.0%. This in particular will be noted by the BoE given the prior data had started to indicate a trend weaker. However, the Average Weekly Earnings data on a 3mth and 6mth annualised data is now indicating a more meaningful slowdown in the annual rate is coming with both rates now in negative territory.

Governor Bailey also spoke yesterday evening and was keen to play down the importance of backward looking economic data. Governor Bailey clearly sees what might be coming later in the week – there is a high chance of a negative GDP print that will get a lot of attention in the media given it would mark an official technical recession for the UK. But Bailey saw signs of “an upturn” in the forward-looking data and coupled with the slow pace of decline in the wage data today will encourage continued caution by the BoE. It won’t alter current market pricing that has the first full rate cut priced for August and that should help provide GBP with further support. A stronger USD bias would imply a continued slow decline in EUR/GBP.   

3 & 6MTH ANNUALISED RATES INDICATE YOY LEVEL SHOULD SLOW

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
GE	10:00	German ZEW Current Conditions	Feb	-79	-77.3	!!
GE	10:00	German ZEW Economic Sentiment	Feb	17.4	15.2	!!
EC	10:00	ECOFIN Meetings	--	--	--	!
EC	10:00	European Union Economic Forecasts	--	--	--	!
EC	10:00	ZEW Economic Sentiment	Feb	20.1	22.7	!!
GE	10:30	German 5-Year Bobl Auction	--	--	2.21%	!
EC	10:40	ECB Supervisory Brd Tuominen Speaks	--	--	--	!!
US	11:00	NFIB Small Business Optimism	Jan	91.1	91.9	!!
US	12:00	OPEC Monthly Report	--	--	--	!!
US	13:30	Core CPI (MoM)	Jan	0.30%	0.30%	!!!!!
US	13:30	Core CPI (YoY)	Jan	3.80%	3.90%	!!!!!
US	13:30	CPI (MoM)	Jan	0.20%	0.30%	!!!!!
US	13:30	CPI (YoY)	Jan	2.90%	3.40%	!!!!!
US	13:30	Real Earnings (MoM)	Jan	--	-0.20%	!
US	13:55	Redbook (YoY)	--	--	6.10%	!
GE	14:00	German Current Account Balance n.s.a	Dec	--	30.8B	!
US	16:00	Cleveland CPI (MoM)	Jan	--	0.40%	!

Source: Bloomberg