Russell 2000 ahead again on cooling inflation

Wall Street rallied today on data showing cooling inflation, again led by the Russell 2000, but celebrating a soft-landing with no further rate hikes might be premature. The Fed is scheduled to release its Beige Book today, summarizing what it sees in the economy, and used in its policy decisions, and this could provide a little more context. Commodities were bullish: oil and gold rose 1.3%, and silver was up by 4.4%.

Bottom-line: risk-on.

TODAY’S MAJOR NEWS

Inflation cooling, reasons to be cheerful

Core inflation falling to 4.8% year-on-year was welcomed as good news by traders, but remember the Fed is targeting inflation of 2% or less. Today’s numbers present more reasons for optimism than we’ve seen recently, as discussed below, but they don’t totally alleviate longer-term concerns. These are good numbers which Wall Street interprets as evidence that we can have a soft landing without a need for the Federal Reserve to do much more than to be patient and to allow what it has already done to work.

Futures markets still see a 25 basis point hike as pretty certain on July 26, but are now pricing in a 27% chance of a 50 basis points by the end of November (down from a 36% chance of two hikes yesterday).

The current path can continue to ease headline inflation numbers, but we continue to believe that we can’t get down to the 2% mandate without inflicting more pain on the labor market and the housing sector. Let’s delve into the detail.

CPI inflation better than expected, slowest increase since March 2021

• Headline CPI was up 3.0% year-on-year in June, a shade below the expected 3.1%, and down from 4.0% in May
• CPI rose 0.2% month-on-month in June, less than the forecast 0.3%, and up from 0.1% in May
• Core CPI, excluding volatile food and energy sectors, was up 4.8% year-on-year in June, less than the forecast 5.0%, and down from 5.3% the previous month
• Core CPI rose 0.2% month-on-month in June, less than the forecast 0.3%, and down from 0.4% in May

Inflation components still offer cause for concern

• Energy commodities saw a 0.8% month-on-month increase, including a 1.0% rise in gasoline prices and a 0.9% rise in electricity costs, partially offset by a 1.7% month-on-month decline in piped natural gas prices
• Used car and truck prices saw a 0.5% decline in, following a couple of months of big gains, and new car prices were flat on the month
• Shelter costs rose by “just” 0.4% on the month, reflecting a long-anticipated slowdown in inflationary pressures in that sector (watch this one, amid signs that the housing sector is starting to heat up again as consumer sentiment improves, while the supply of housing remains tight)
• Services less energy rose by just 0.3% month-on-month (the service sector remains vulnerable to wage inflation pressures, with recent data showing the jobs market perhaps tightening again)

Fight inflation or defend Bank’s, Minneapolis Fed President writes

Federal Reserve Bank of Minneapolis President Neel Kashkari wrote that managing inflation and supporting financial stability could still be an issue for the Fed in an essay released Wednesday. He argued that banks must be prepared for higher interest rates in case policymakers need to lift rates further to combat entrenched inflation. The banking system is currently “sound and resilient,” he wrote, but stresses could re-emerge again, as they did in March when high inflation and rapid rate increases helped trigger the failure of several regional banks. “However, if inflation proves to be more entrenched than expected, policy rates might need to go higher, which could further reduce asset prices, increasing pressure on banks,” he said. “In such a scenario, policymakers could be forced to choose between aggressively fighting inflation or supporting bank stability.”

TODAY’S MAJOR MARKETS

Equity markets

• Markets rallied in morning trade, with the Russell 2000 again leading the way up 1.4%, with the Nasdaq and S&P 500 up 1.2% and 0.9%, respectively
• Global markets were mixed, with the FTSE 100 and Dax up 1.8% and 1.5%
  respectively, while the Nikkei 225 was off 1.4%
• The VIX, Wall Street’s fear index, fell back to a 12-month low of 13.7

Currencies and Bonds

• The dollar index fell 1.1% against a basket of currencies to 100.6, hurt by moderating interest rate expectations
• Euro/dollar and Sterling/dollar were up 1.1% and 0.4% respectively, which Yen/dollar fell 1.4%
• Bonds rallied strongly, with yields on 2- and 10-year Treasuries falling back to 4.74% and 3.86% respectively

Commodities

• Crude oil prices were up 1.3% to $75.6 per barrel
• Gold and silver prices were up by 1.3% to $1,962 per ounce, and up by 4.4% to $24.3 per ounce, respectively
• Grain and oilseed markets were down sharply after USDA adjusted its balance sheets following the surprise changes in corn and soybean acreage on June 30^th
• The two biggest surprises today were a much bigger winter wheat crop than expected, and much larger new-crop soybean ending stocks than expected
• Bearish wheat and soybean reports pulled the support out from beneath the corn market

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

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