Will Tamer CPI Cause the Fed to Hold Fire?

The tamer US CPI reading is what could pave the way for the Fed to hold fire on interest rates. Headline CPI came in at 4% y/y (vs. 4.1% expected and 4.9% previous). However, there were divergent reactions to the inflation data across different asset classes. With headline figure coming in softer and adding to the argument for a Fed pause this week, equities rallied and the USD declined. Though with US treasury yields rising, it seems the bond market focused more on the persistently high core inflation.

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Looking at US indicators over the past month, we can see slowing wage growth and easing headline inflation. So, for the Fed voting members with dovish interest rate inclinations, and I include Chairman Powell in this camp, there is enough evidence to justify letting the dust settle from the previous ten rate hikes and hitting the pause button this month. Though we have seen that there is another ‘camp’ within the FOMC who thinks more still needs to be done to stem inflation. As such, it will be Powell’s remarks afterwards which will likely be the source of volatility for financial markets. Traders will be going over every word by the Fed Chairman with a fine-tooth comb searching for clues regarding the rate trajectory for July and beyond.

Stronger US treasury yields sent the gold price lower, which meant that precious metal was unable to capitalise on a pullback in the USD. Gold is trading at the lower end of its recent range and is currently sitting above support at US$1940. Safe-haven demand has dried up for the moment which is stemming buying inflows for gold. In the absence of safe-haven demand, any move by gold back to the top-end of the recent range (i.e., US$1970 and above) could be contingent on a lowering of the US yield outlook from the FOMC. Though I expect that even if the FOMC does sit tight at this meeting (and hold rates steady), the central bank will endeavour to keep the door widely open for a possible move higher in July.

Oil staged a bounce-back, but current price levels are still showing signs of distress. The WTI contract is trading at sub US$70 which goes to show that despite the best efforts of OPEC+ to influence price from the supply side, it is the demand outlook which is acting as the biggest constraint on the oil price. But there has been some good news, with OPEC reaffirming its demand outlook and the early steps of stimulus in the Chinese economy. In reducing short term lending rates, the PBOC is taking a step in the right direction as far as investors are concerned but the feeling is that more aggressive stimulus measures will be needed to truly kickstart the Chinese economy.

Asian indices were ticking higher following the positive Wall Street lead. However, there was still an air of caution exhibited in markets ahead of the FOMC meeting, with financial markets remaining ultra-sensitive to the US interest rate outlook. So, while there is a mood of positivity in markets, whether that momentum can be maintained will be largely dependent on whether the Fed upsets the apple cart with a hawkish interest rate tone. 

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