CPI paves the way for FOMC pause

USD: CPI data likely provides Fed reassurance to pause

The US rates market clearly responded to the CPI data yesterday by removing the risk premium on a surprise rate hike this evening but also proceeded to remove a certain degree of the rate cuts priced into the curve for 2024 with those SOFR contracts down about 12-14bps in price. Investors perhaps saw the CPI report as enough to allow for a “skip” tomorrow but not enough to remove the risk of a hike further out or certainly not enough to build on the pricing of a pivot to rate cuts as quickly as implied by market pricing. No doubt there was a degree of a “sympathy-move” related to the very strong wage data in the UK, which resulted in the SONIA futures strip plunging by over 30bps with the Dec 2023 contracts 15bps off an implied 6.00% rate.

We still question the logic of a “skip” scenario from the FOMC. Not hiking this evening will certainly be accompanied by a strong message from Chair Powell that the FOMC do not believe they are necessarily finished and remain ready to hike again. An increase in the dots profile to add another 25bp hike in H2 2023 seems a useful way of relaying that message. But being very forceful on hiking again is also going to be difficult simply because the FOMC will have paused this evening. So there will we believe be an inevitable degree of ambiguity in the hawkish communication in order to counter any over-reaction that results in an unwarranted easing of financial conditions.

Of course an increased dot in 2023 and/or in 2024 along with a hawkish communication tonight will potentially counter any easing of financial conditions and could see the dollar strengthen. But beyond the very near-term reaction, the question is would dollar strength and higher rates be sustained?

We see it as unlikely. In the end, a pause is a pause and will likely be viewed ultimately  as that rather than a “skip” given the incoming data is likely to continue to warrant an end to this tightening cycle.

The inflation data yesterday is another that points to a continued softening of inflation pressures. The headline YoY rate dropped to 4.0% partly on energy base-effects. We will have another big drop in the June data with a YoY rate of possibly 3.0%. The 4.0% YoY rate was the lowest since March 2021 when the inflation surge really began and marked the first post-covid YoY print above the 2.0% inflation target. From the April 2021 level of 4.2%, it took 14mths more to hit the cyclical high in June 2022. It has taken 11mths to reverse the move and a little more! Inflation is dropping faster than it surged. The sticky inflation component (supercore) is also decelerating – a 0.24% MoM gain after a 0.11% gain in April was the slowest two-month gain since Aug/Sept 2021. The wider core CPI measure (two 0.4% MoM gains) includes two months of consecutive 4.4% gains in used car prices which won’t last. Indeed, if you exclude the used cars component and shelter from core CPI, the 3mth annualised rate is now at 2.3%! Disinflation is becoming more and more prominent. We think the Fed will pause for good this evening, although Powell may try and convince us otherwise. Ultimately, it will mark an important point in prompting US dollar weakness.

3MTH & 6MTH ANNUALISED US CORE CPI EX-SHELTER & USED CARS

Source: Bloomberg & Macrobond

GBP: GDP growth as expected with more hikes on the way

The employment data from the UK yesterday, which we outlined here, were a real shocker with wage inflation much stronger and certainly reinforcing the need for further rate hikes by the BoE. We already were assuming two further rate increases by the BoE to 5.00% by August and the wage data yesterday certainly makes that scenario very likely. There has been understandably some increased speculation of a 50bp hike, either next week or at the August meeting. While the August meeting will include updated forecasts we don’t view that with the same significance as before. Governor Bailey has already indicated the model is flawed and not being used as much in determining policy decision. If the BoE is to go 50bps, next week seems more likely.

But we suspect the BoE will stick to 25bp hikes. Other data remains more mixed and there is still compelling reason to believe inflation will fall, albeit more slowly than elsewhere. This morning we had the release of GDP data for April which was in line with market expectations – a 0.2% m/m gain after a -0.3% drop in March meant the 3mth/3mth remained at 0.1%. But manufacturing and construction data were weaker than expected with growth focused on the services sector. The health sector also weakened reflecting striking doctors in the NHS. Real estate was also weak and could reflect the emerging impact of past monetary tightening.

Indeed, it is the housing market where we are likely to see increasing stress as past monetary tightening feeds into the economy. Remember, according to the BoE as of May, prior to the last hike, of the 415bps of tightening at that stage, only 71bps had actually hit the housing market. A bigger impact is underway now with 1.3mn mortgages resetting since April through to year-end. This week mortgage providers are pulling products to reset rates as swap rates surge to new cyclical highs. 2-year fixed mortgage rates are set to drift over 6%.

While current rates market pricing looks excessive to us, now is not the time to dispute that, which points to GBP remaining well supported over the near-term.

UK RATES VIEW RELATIVE TO EUROPE DRIVING EUR/GBP LOWER

Source: Macrobond

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period		Consensus	Previous	Mkt Moving
US	09:00	IEA Monthly Report		--	--	--	!!
EC	10:00	Industrial Production (YoY)		Apr	0.8%	-1.4%	!
EC	10:00	Industrial Production (MoM)		Apr	1.0%	-4.1%	!!
GE	10:30	German 10-Year Bund Auction		--	--	2.310%	!!
US	12:00	Mortgage Refinance Index		--	--	409.7	!
UK	12:30	NIESR GDP Estimate		--	0.1%	-0.1%	!!
UK	12:30	NIESR Monthly GDP Tracker		--	--	0.1%	!!
US	13:30	Core PPI (MoM)		May	0.2%	0.2%	!!
US	13:30	Core PPI (YoY)		May	2.9%	3.2%	!
US	13:30	PPI ex. Food/Energy/Transport (YoY)		May	--	3.4%	!
US	13:30	PPI (YoY)		May	1.5%	2.3%	!
US	13:30	PPI ex. Food/Energy/Transport (MoM)		May	--	0.2%	!
US	13:30	PPI (MoM)		May	-0.1%	0.2%	!!!
CA	13:30	New Motor Vehicle Sales (MoM)		--	--	151.0%	!
US	17:00	Thomson Reuters IPSOS PCSI		Jun	--	52.47	!
CA	17:00	Thomson Reuters IPSOS PCSI (MoM)		Jun	--	49.54	!
US	19:00	Interest Rate Projection - 1st Yr		Q2	4.6%	4.3%	!!
US	19:00	Interest Rate Projection - 2nd Yr		Q2	3.3%	3.1%	!!
US	19:00	Interest Rate Projection - Current		Q2	5.3%	5.1%	!!
US	19:00	Interest Rate Projection - Longer		Q2	2.5%	2.5%	!!
US	19:00	FOMC Economic Projections		--	--	--	!!!
US	19:00	FOMC Statement		--	--	--	!!!
US	19:00	Fed Interest Rate Decision		--	5.25%	5.25%	!!!
US	19:30	FOMC Press Conference		--	--	--	!!!

Source: Bloomberg