We are having a great week in terms of US inflation news. After Wednesday’s data showed that the US headline inflation slowed to 3%, and core inflation fell to 4.8% – both lower than what analysts had penciled in, yesterday’s producer price inflation data also came in lower than expected. The monthly PPI eased to 0.1%, perhaps the last positive figure we see before sinking into negative territory in the coming months, and core PPI fell to 2.6%. One more good news, some underlying details in the PPI report, including health care and hotel accommodations, are used to compute the Fed’s favourite PCE Price Index that will be released in the coming weeks – which could also benefit from softening inflation trend.
As a result, the US 2-year yield fell another 15bp yesterday and hit 4.60%, while the 10-year yield retreated below 3.80%. The US dollar index slipped below the 100 mark. This is the first time the US dollar index has traded below this level since April 2022, as the Federal Reserve (Fed) is not seen getting more aggressive than this when inflation is slowing. Plus, one of the most aggressively hawkish Fed members, James Bullard, resigned yesterday. The probability of another 25bp hike at the Fed’s July meeting didn’t change much. It’s still given more than 90% probability. But the chances of another rate hike following the June hike are getting blurrier, so equity markets cheer the softening Fed expectations. The S&P500 extended gains yesterday and closed the session above the 4500 mark for the first time since April 2022, while Nasdaq 100 rallied another 1.73%. Amazon jumped to a 10-month high yesterday after reporting record sales during its Prime Day. Happily, this week’s inflation numbers were sufficiently soothing, so that the record Prime Day sales didn’t boost inflation expectations. MAMAA stocks were up by 1.72%. Crude oil on the other hand rallied past the 200-DMA, near $77pb, and consolidates at around that level this morning. Supply shortages in Libya and Nigeria are pushing price higher but the IEA says that global oil demand won’t rise as much as they previously forecasted due to the weakened economies of developed nations. It will increase by around 2.2mbpd, +2%. This is 200’000 barrels less than previously forecasted. It could help bring the bears back to the market at around the 200-DMA. The $77/80 barrel resistance will be difficult to drill because the market is now approaching overbought conditions and a key technical level is generally a good moment to sell, and because otherwise it would be bad news for inflation expectations, and the Fed.
One good news is that, although the resilience of the US jobs market remains a major concern for the Fed, the stock market rally could be a much smaller concern because the Fed recently launched a financial conditions index, an index that takes into account bond yields, mortgage rates, the stock market, Zillow’s house price index and the dollar’s value on global currency markets to determine how the market conditions would impact growth. And the index showed that the financial conditions in the US became increasingly less favourable this year and hit an all-time peak in December when they were more of a drag on growth than at any time in recent decades, apart from the 2008 financial crisis. And at the current levels, the market conditions remain historically unfavourable to growth – and that despite the stock market rally.
Slow growth is bad for stock valuations, but investors remain focused on earnings, rather than the overall financial conditions, and we have good news on the earnings front so far. Delta Airlines for example jumped to the highest level since April 2021 yesterday after reporting after announcing record revenue and profit in Q2 and saying that they are ‘looking at a very, very strong Q3’, as indicated by their guidance, and that they could have a strong Q4 as well. While PepsiCo rallied almost 2.40% after revealing a strong quarter thanks to higher prices they could ask from customers, and after raising its sales and earnings estimates. Today, some big US banks will go to the earnings confessional. The big banks benefited from ample deposit inflows following the Silicon Valley Bank (SVB) collapse in March, but their net interest income is expected to have declined, credit costs are normalizing, and they have increased expenses due to inflation. So, the numbers could be soft, but what matters for investors is the comparison between the numbers and expectations. If expectations are better than the actual numbers, stock prices will not be hurt. And that’s why Goldman Sachs is out trying to dampen expectations, so that the results can more easily beat them!
