Bulls back in charge on better inflation data

Financial markets are tending towards risk-on ahead of tomorrow’s Fed meeting, with no worse than expected inflation data pointing to no immediate rate increases. Traders believe that the bull market has resumed, looking forward to declining rates in the second half of the year.

Bottom line – risk-on.

 

TODAY’S MAJOR MARKETS

Equity markets

• The Nasdaq 100 and S&P 500 indexes were both up 0.7%, while the more broadly based Russell 2000 was up 1.3%. Smaller more cyclical and tech stocks continue to lead in the US
• Abroad, the Nikkei, DAX and the FTSE 100 indexes rose 1.8%, 0.7%, and 0.3%, respectively. Japan and emerging markets are leading
• The VIX, Wall Street’s fear index, rose 3% to 14.6 after a long period in decline, but readings don’t give cause for concern

Currencies and Bonds

• The dollar index was slightly weaker this morning, at 103.3, down 0.3%. Still no sign of the dollar breaking out of its narrow trading range
• Euro and sterling x-rates versus the dollar were up 0.3% and 0.7%
• Yields on 2- and 10-year Treasuries rose to 4.69% and 3.82%. Bond yields should decline if inflation and rates head lower

Commodities

• Gold prices fell back 0.7% to $1,956 per ounce, failing to hold the psychologically important 2K mark
• Crude oil prices rebounded, up 3.8% to $67.3 per barrel, with supply-side bulls gaining the upper hand on anticipated OPEC+ output reductions
• Grain and oilseed markets were mostly higher, supported by weaker crop ratings in the Midwest, a weaker dollar, and specific news about government support for ethanol fuel

 

DISCUSSION

Improved inflation data boosts ‘pause’ storyline

Better-than-expected consumer price index (CPI) inflation data released this morning spurred belief that the Fed will pause interest rate hikes at tomorrow’s meeting. Core inflation remains sticky, but declining energy prices helped drive the headline number lower. We are scheduled to get producer price index (PPI) inflation data tomorrow, but it’s unlikely to sway views.

Wall Street adopted a cautious "risk-on" sentiment today, choosing to see the proverbial glass as "half full”, also justifying the resumed bull market in equities. The Fed has been focused on the core numbers that show the stickiness of inflation that cannot be brought down to the 2% mandate without the continuation of hawkish policy. That’s especially true for a Fed that has repeatedly stated that it would rather error on the side of higher for longer on rates.

Fed fund futures continues to price in expectations of a pause in June, and a 25-basis point increase in the Fed's benchmark rate in July, followed by rate cuts by the end of the year – although recent data and comments by Fed members suggest that the pause may be much longer than the market anticipates before cuts begin.

CPI Data by the numbers

• Headline CPI was up 4.0% year-on-year in May, below an expected 4.1%, down from 4.9% in April
• Core CPI, excluding the more volatile food and energy sectors, was up 5.3% year-on-year in May, matching expectations, down from 5.5% in April
• The Cleveland Fed’s “now-casting” inflation indicator had predicted the headline CPI to be up 4.13% year-on-year, and the core CPI to be up 5.34% year-on-year. So, actual numbers came in slightly below those expectations

US Core CPI, YoY % change

• Breaking down the numbers, the decline in energy prices was largely behind the drop in the headline numbers in May, with energy commodities down 20.4% year-on-year
• The biggest drop in that sector was in fuel oil, which fell 37.0% year-on-year
• Electricity saw a 1% month-on-month decline in May
• Core CPI held up due to a 0.6% rise in commodities less food and energy, along with a 4.4% month-on-month increase in used cars and trucks, and 0.6% month-on-month increases for medical care commodities and for shelter

 

China-Arab trade deals

China signed deals worth $10 billion with Arab countries during its recent two-day Arab-China business conference. The largest, $5.6 billion, between Chinese electric car maker Human Horizons and Saudi Arabia’s investment ministry, aims to help Saudi Arabia to establish an EV manufacturing industry, including automotive research, manufacturing, and eventually selling EVs in Saudi Arabia.

This allows Chinese companies to build the infrastructure, and the electric vehicles, running new energy projects in the overseas market, thus taking pressure off struggling Chinese manufactures due to weaker demand from Western countries. It’s another example of how China is using its Belt and Road initiative to diversify away from the West while making participating countries more dependent on it. This is marginally disappointing for Tesla, Ford and GM, with increasing competition in foreign growth markets.

 

Analysis by Arlan Suderman, Chief Commodities Economist. [email protected].

Market outlook by Paul Walton, Financial Writer. [email protected].