Markets Go ‘All In’ On September Fed Cut Despite The Sting In CPI’s Tail

WHERE WE STAND – I’ve often wondered what the easiest job in finance is.

No, it’s not being a sell-side strategist, before any wags get that jibe in. Instead, it might be that of a JGB market maker.

Why, I hear you ask; well, the 10-year JGB didn’t trade at all yesterday, the first time that’s happened since March 2023. I suppose it’s alright for some, putting their feet up, while the rest of us slave away, enduring what’s now the fourth heatwave that London has experienced this summer.

For those outside the moribund world of JGB trading, yesterday’s US CPI figures highlighted proceedings.

In short, to coin a golfing phrase, it was a case of ‘headline for show, core for dough’. Yes, headline prices rose at a pace bang in line with expectations, 0.2% MoM, and 2.7% YoY, last month. That, though, is where the good news stops – core inflation rose 3.1% YoY, the fastest pace since February; ‘supercore’ prices rose 3.2% YoY, also the fastest pace since February; core goods prices rose 1.2% YoY, the fastest pace in more than two years; and, last but not least, core services prices rose by 3.6% YoY for the fourth month running.

Short of being a dovish report that lays to rest all concern over upside inflation risks, I’d argue this was actually a hawkish one which lays bare how those very risks are now materialising.

It is also one which, to me, reinforces the view of many FOMC participants that inflation is further away from reaching the Committee’s objective than the labour market is. In fact, headline CPI has now been running north of 2% for the last 53 months in a row, while headline unemployment has been below 4.5% (generally considered as ‘full employment’) for the last 45 months running.

I’d argue, then, that the market  is getting quite a long way ahead of itself, and that a degree of complacency is setting in, when it comes to pricing the September FOMC meeting. The USD OIS curve now sees a >90% chance of a 25bp cut in mid-next month, while also discounting over 60bp of cuts by year-end.

All eyes, then, now turn to Chair Powell’s rather tricky-looking speech in Jackson Hole next week. Either, J-Pow seeks to pushback on pricing for September, this being the ‘right’ thing to do, but likely causing one hell of a tantrum in financial markets; or, Powell endorses that pricing, this being the ‘easy’ option, albeit one which means we could wave goodbye to any pretence of the FOMC actually seeking to return inflation to the 2% objective.

Clearly, a certain Mr Trump is in the latter camp, ranting away yet again yesterday that Powell “must lower the rate”, while also saying he’s considering a “major” lawsuit against the Fed Chair, pertaining to the ongoing building renovation project.

This is, in my view, a load of cobblers – both in terms of the idea that renovating a historic building is somehow cause for Powell’s ouster, and in terms of thinking that there is any upside to trying to oust Powell. We’re mere weeks away from his replacement being named, and in any case a lawsuit would probably take years to get through the legal system, by which point Powell’s term as Chair would be over anyway. Frankly, all this feels like noise, with a very slim possibility of any action following it.

If you reckon that’s bad, though, how about Trump’s pick to run stats at the BLS suggesting that the agency scrap publication of the monthly jobs report. I guess simply not issuing the data is one way to prevent bad data ever being published, although it’s quite obviously another leaf out of the banana republic playbook.

At risk of repetition, all this reinforces my long-running bearish USD view, and only encourages capital outflows from the States to quicken. The buck softened against all G10 peers yesterday, with the ‘path of least resistance’ clearly leading to the downside in my mind. Even if there are hawkish risks to Fed pricing here, structural headwinds from the erosion of economic precedent, and the independence of key agencies, will be incredibly tough to overcome.

Besides the dollar, though, and some modest demand seen in gold, markets elsewhere largely shrugged off both of the aforementioned catalysts.

Instead, focus fell squarely on the dovish repricing of Fed policy expectations post-CPI.

Hence, stocks rallied across the board on Wall Street, with the S&P notching a new record high, as the risk rally goes from strength to strength. The bull case remains a convincing one, with earnings growth solid, and a cooler tone on trade continuing to prevail, all the while dovish policy expectations help to provide a cushion against any worries that the economy may be softening under the surface. With the event risk docket now pretty barren until Powell’s remarks next Friday, the path of least resistance is clear to the upside for the time being.

Treasuries, in contrast, appear to be showing us exactly what might happen if & when the Fed deliver rate cuts into an inflationary environment, as evidenced by the steep sell-off at the long-end, and substantial steepening of the curve, yesterday. I’d not be at all surprised to see the benchmark 30-year stage another attempt to tag the 5% mark before Jackson Hole.

LOOK AHEAD – There’s not likely to be much going on today, barring any unexpected headlines.

The data docket is totally barren across DM; three Fed speakers are due, though one (Barkin) will simply repeat what he said yesterday; and, the only notable earnings release comes from Cisco after the close.