Some relief for markets

CPI inflation data (for June) in the US proved to be the main driver of markets yesterday. They came in a good bit softer than the consensus forecast, prompting an easing of Fed rate hike expectations, a decline in bond yields, a rebound in stocks, and some moderate weakening of the dollar. In FX, the euro has bounced to around $1.1430 against the US currency, from pre-inflation data levels of just under $1.14, while sterling is trading north of $1.34 again, rebounding from circa $1.3380 before the data. This in turn leaves EURGBP little changed from yesterday morning’s levels at about £0.8525.

The weaker than expected US inflation data contributed to some paring back of Fed rate hike expectations. The market has pushed out the timing of a 25bps increase in the federal funds rate to December (from September) and is now pricing in about 45bps of hikes over the next year or so (down from over 50bps). The easing of rate expectations contributed to a fall in US bond yields, with 2- and 10-year yields ending 10bps and 5bps lower on the day respectively. Both German and UK yields retreated from their highs of the day to finish broadly unchanged overall, amid some easing of ECB and Bank of England rate hike expectations also (with the market back to pricing in circa 50bps of hikes over the next year, down from more than 60bps).

Headline and core CPI inflation in the US both surprised to the downside in June. Headline inflation fell to 3.5% from 4.2% in May, on the back of an energy-driven 0.4% decline in prices on the month, while core inflation (which excludes energy and food prices) fell to 2.6% from 2.9% with core consumer prices flat on the month. Within core inflation, both core goods inflation and core services inflation declined in June, to 0.8% and 3.2% respectively from 1.1% and 3.4% in May, the fall in core goods inflation evidence that the tariff-related increase in prices may have run its course.

Fed Chair Warsh gave nothing away regarding the near-term path for interest rates at his appearance before the House Financial Services Committee. Other than noting that yesterday’s CPI data did not mean that it was “mission accomplished” as far as returning inflation to  target was concerned, he reiterated that the Fed has “no tolerance for persistently elevated inflation” and  has “a resolute commitment to restoring price stability.”

For the day ahead, economic data scheduled include industrial production for May in the Euro area and producer prices (June) and the latest Fed Beige Book in the US. Fed Chair Warsh makes a second appearance in Congress, this time testifying before the Senate Banking Committee, while there are a few ECB/BoE members due on the wires over the course of the day.