Markets are in wait-and-see mode this morning, with global equity, FX and bond markets for the most part subdued in the run up to today’s key data; the August US CPI report, which is set for release shortly at 1330BST. FOMC policy makers continue to reiterate their stance that the spike in inflationary pressures in the US is transitory and, given the expectation that inflation will fall back sharply towards their 2.0% target in 2022 and beyond, continues to look at labour market benchmarks as the main determinant of policy making decisions. That being said, worries that inflation may linger at elevated levels longer than the FOMC expects (i.e. that the spike is not “transitory”) are growing on the FOMC and a much higher than expected headline or core CPI number for August could further feed these fears, which markets might see as “putting pressure” on FOMC members to agree on their QE tapering timeline at next week’s policy meeting. Thus, a much higher than expected YoY CPI number (say of closer to 6.0%) could trigger USD strength, a spike in yields and a drop in gold (and maybe also stocks). Conversely, a much weaker than expected number (say CPI drops under 5.0% YoY) would strengthen confidence in the “transitory” argument and could be seen as easing pressure on Fed policymakers to wind down QE more quickly; some of the more hawkish FOMC members want to wind QE purchases down more quickly to make “space” for rate hikes next year, just in case they are needed to tame inflation. In this circumstance, we could see the opposite market reaction (USD down, yields down, gold and stocks up). But most likely, if the inflation numbers aren’t too different from expectations, markets will shrug, and focus will return to labour market data as the most important variable for FOMC policymaking.
Taking a closer look at how markets are performing this morning ahead of the data; US equity index futures are flat, with S&P 500 futures around the 4470 mark, with conditions having settled down following yesterday’s 50-point swing in the cash index between 4450 lows and highs just under 4500. That means the major US equity index is still trading about 1.7% below recent record levels recorded at the start of the month; some equity analysts have been talking about concerns about seasonally weak performance September and elevated equity valuations as the FOMC moves closer to winding down its stimulus as reasons why stocks have been driven lower by profit taking over the course of the last week. European equity markets are a little softer, with Stoxx 600 down just over 0.1%, amid some underperformance being seen big luxury names given concerns about another mini-Covid-19 outbreak in China; 59 locally transmitted cases were picked up on Tuesday in the Fujian province, up from 22 the day before, raising the risk of more disruptive lockdowns there. In terms of bond markets, yields are a little higher in both the US and Europe, with 10-year US pushing back towards 1.35% and German 10-year yields this morning hitting two-month highs and nearly breaking above -0.3%. Bond strategists are citing high Eurozone debt supply this week as pushing up yields modestly there. In terms of FX, the DXY is pretty much flat on the day around the 92.60 mark, with the 50DMA acting as a magnet ahead of key US inflation numbers.
Sticking with FX markets; GBP is one of the best performing currencies in the G10 this morning, with GBPUSD eyeing multi-week peaks just under the 1.3900 level, after a solid UK labour market report boosted confidence in the durability of the UK’s economic recovery and, in the eyes of many FX strategists, underpinned expectations that the BoE will start lifting interest rates ahead of the Fed and ECB. To recap this morning’s UK jobs numbers; the unemployment rate fell to 4.6% from 4.7% in July as expected, but July’s average earnings growth (including bonuses) came in hotter than expected at 8.3% YoY (forecasts were for a drop to 8.2% from 8.8% in June) and the UK economy added a record 241K jobs to payrolls in August, taking total payroll employees back above pre-pandemic levels. Meanwhile, job vacancies hit record levels above 1M. The data suggests that the UK labour market continues to perform well despite the unwinding of the government’s furlough scheme, something that should please policymakers at the BoE. Ahead, GBP traders are now turning their focus to the August inflation report out tomorrow; supermarket price data from Kantar out this morning showed prices spiking more than 1.0% in the last four weeks, adding some upside risks. The BoE expects the YoY rate of CPI to hit about 4.0% by the year’s end, before moderating next year. An upside surprise tomorrow could trigger further hawkish shifts in money market pricing for BoE rate hikes next year.
At the other end of the G10 performance spectrum is the Aussie dollar, which was weighed overnight by dovish rhetoric from RBA Governor Lowe, which overshadowed improvements in the NAB business confidence survey and data revealing stronger than expected house price growth in Q2. In summary, and though he reiterated the RBA’s expectations that the Australian economy will recover strongly in 2022, RBA Governor Lowe criticised money markets for pricing in a possibility of rate hikes in 2022 or 2023 and strongly reiterated his guidance that the bank will not be hiking rates until 2024. This, he explained, was due to subdued comparatively inflationary dynamics in the Australian economy. AUDUSD has slipped from yesterday’s peaks around the 0.7370 area to back under the 0.7350 mark and looks on course to test the 21DMA at just above the 0.7300, which would also see the pair testing lows for the month. The rest of the G10 currencies flat to modestly weaker on the session versus the buck, with FX, as other markets, in wait and see mode ahead of today’s key US CPI report.
The Day Ahead
Canadian Manufacturing Sales data for July will be released at the same time as US CPI (1330BST) but is unlikely to have too much of a material impact on CAD as the data is unlikely to factor into BoC policymaking thinking too much. Otherwise, there is little else on the economic calendar to get excited about and so markets are set to be driven by the US CPI report and what, if any, markets perceive its implications on FOMC policy making will be.