US equity markets are flat and US bond markets relatively subdued ahead of today’s key data US data release, the release of the May Consumer Price Inflation report at 1330BST. E-mini S&P 500 futures currently trade close to the 4220 mark and 10-year nominal US bond yields have risen about 1bps to consolidate bang on the 1.50% mark. Global stock market sentiment was given a modest boost overnight amid constructive US/China commentary (reportedly high-level US and Chinese commerce officials spoke on the phone regarding finding pragmatic solutions to differences and will aim to push forward with trade and investment ties).
As discussed in yesterday’s morning brief, recent bond market price action (the roughly 10bps drop in nominal yields and inflation expectations since the start of the week) signal that concerns about inflation are easing and some banks have pointed out that movement in equity markets this week has sent a similar message, given the outperformance of the share prices of companies selling goods/services with high demand elasticity versus those selling goods/services with low demand elasticity (i.e. increased concerns about inflation tend to benefit stocks who sell products/services that consumers will need to continue to purchase no matter the cost and what we have seen is the opposite). Given the recent moves which seem to suggest easing inflation concerns, some banks are arguing that this leaves markets more “vulnerable” to an upside inflation surprise this afternoon, i.e. if inflation comes in a lot hotter than expected, this could reignite inflation concerns and see some of the recent market trends (i.e. lower nominal yields and inflation expectations) reverse.
With regards to what all this means for the US dollar; if the above posited scenario were to materialise (hotter than expected inflation report reignites inflation concerns), then how the dollar reacts depends largely on how the market perceives that the Fed will react to the higher-than-expected inflation report. Does the market think the Fed will 1) stick to its guns in predicting that the current spike in inflation will be transitory or 2) become concerned about recent inflation developments and bring forward its policy normalisation timeline? The former case (the one where inflation is very high but the Fed continues to remain highly dovish) would be very bearish for the dollar (via a further drop in real yields which are further compressed by inflation expectations), while the latter case (the one where the Fed essentially panics and makes a hawkish pivot) is likely to be a massive positive for the dollar (via a spike higher in real yields as inflation expectations come down and markets anticipate higher interest rates ahead). To sum up, in the case of a hotter than expected CPI report, the dollar’s reaction depends on how the market perceives the Fed will react to the data. There is no way of accurately predicting this, but my inclination is to suspect that even in the case of a very strong CPI report, markets will continue to buy into the Fed’s transitory inflation story and will continue to expect dovishness from the Fed at next week’s policy meeting. This would be a net negative for the US dollar, but the immediate market reaction could be highly choppy given the presence of algorithms etc. in the market, complicating things. Conversely, most analysts agree that a cooler than expected inflation report is likely to be seen as having dovish implications for Fed policy (i.e. by in part vindicating them in their prediction that inflation will be transitory), which would likely be USD negative.
In terms of commodities, crude oil prices have recovered from an overnight pull back and look to be gradually edging higher towards another potential test of recent cycle highs. It appears that market participants have been eager to “buy the dip” after the crude complex came under pressure in wake of an unexpectedly bearish weekly US EIA crude oil inventory report yesterday – some analysts argued that this report showed weaker than expected demand at the start of the peak US driving season, but judging by how crude has recovered from lows, it seems that faith in the global oil demand recovery story remains intact. WTI is currently trading pretty much bang on the $70.00 level having dipped under $69.50 overnight and trades about 50 cents below this week’s multi-month highs, while Brent is trading back close to $72.50, having dipped as low as $71.50 overnight, not too far from this week’s highs around $72.85. Crude oil traders are now on notice for the release of OPEC and the International Energy Agency’s monthly oil market reports over the next two days for updated oil demand growth forecasts and more oil market commentary from top officials. In terms of industrial metals, Chinese iron ore prices continue to pick up, with benchmark iron ore prices ending Thursday’s Asia session up 0.7% at not too far from the CNY 1200 per tonne mark, meaning gains of about 32% on the year. Prices are still a fair amount lower from highs set back at the start of last month (during which time benchmark iron ore prices were up about 44% on the year), with the action taken last month by Chinese authorities to cool price increases seemingly still weighing on the complex. However, continued faith in the global economic recovery story as well as continued expectations for steel production curbs in China to address pollution are underpinning prices. Turning to precious metals; the main event of the day for gold is the upcoming US consumer price inflation report for the month of May and it seems likely that price action is likely to remain subdued ahead of then. At present, the precious metal trades around $1880, a little lower on the day as US real yields see a very modest rise and nominal US yields stabilise, but spot prices remain comfortably above last week’s lows in the $1850s.
Turning to other markets; we recently had the ECB rate decision, where the bank left interest rates unchanged as expected and indicated that it will continue to conduct PEPP purchases at an accelerated pace. The bank’s guidance was otherwise left unchanged and there was not much by way of substantial changes to its statement. ECB President Christine Lagarde will be speaking to the media in the post-ECB meeting press conference which kicks off at 1330BST. In terms of the market reaction to the rate decision so far; EURUSD saw very little reaction and on the day, the pair is still flat, with the ECB meeting going largely as expected and as market participants seemingly look ahead to key US inflation data coming up shortly. European stock and bond markets showed a similarly subdued reaction.
Looking at the rest of FX markets; the Loonie is flat ahead of the release of key US data, with USDCAD just above 1.2100 at present. Yesterday’s BoC rate decision did not have much of a meaningful impact on the currency. The bank held rates unchanged at 0.25% and maintained the month pace of asset purchases at CAD 3B, both as expected. The bank said economic developments had been broadly in line with its recent forecasts released back in April and maintained its forward guidance on interest rates (i.e. could see hikes in late 2022). All in all, nothing surprising from the bank and nothing to shift monetary policy expectations, hence the lack of movement in the Loonie.
Elsewhere in G10 FX, having underperformed its peers modestly as of late, GBP remain at risk of growing Brexit angst as tensions flare regarding the implementation of the Northern Ireland protocol and the US appears to be taking the side of the EU (Biden is set to warn to the UK to protect the Good Friday agreement and is reportedly accusing the UK of inflaming tensions). GBPUSD for now trade close to the 1.4100 level, a level which has formed the base of the currency pair’s recent ranges, hence if the pair does break out to the downside, technical selling could come into play and push it towards 1.4000. Meanwhile, JPY, AUD and NZD are all roughly flat on the session versus the buck as they await US CPI, with USDJPY around 109.50 still, AUDUSD still meandering below 0.7750 and NZDUSD ranging around 0.7175. NOK is the G10 underperformer, weighed by this morning’s softer than expected Norwegian core CPI report.
The Day Ahead
As noted numerous times above, US CPI at 1330BST (for the month of May) will be key. Markets expect headline CPI to rise 0.4% MoM and 4.7% YoY in May (the former back down from 0.8% and the latter up from 4.2% in April). Core CPI will be just as closely watched and is expected to rise at a rate of 0.4% MoM and 3.4% YoY (the former back down from 0.9% and the latter up from 3.0% in April). There will be some focus on the “stickier” subcomponents, i.e. the cost of shelter – if this is seen to be rising faster than expected, this would undermine the “inflation is transitory” argument. In terms of other key events, ECB President Lagarde will start her post-ECB meeting press conference at 1330BST, and US weekly jobless claims numbers will also be released at that time. Thereafter, a 30-year US government bond auction and a speech from BoC Deputy Governor Lane, both at 1800BST, will turn some heads. But the tone of the day will be set by US CPI.