• Treasuries rallied and the dollar weakened after data, showing US inflation cooled and retail sales contracted last month, signalled uneven economic growth as the Federal Reserve is set to deliver its latest rate decision. Stocks continued to stabilize after a two-day tech selloff, with European and emerging-market equities advancing.
• US inflation surprised on the downside. Headline CPI fell 0.1% M/M and eased to 1.9% Y/Y from February’s peak of 2.7% Y/Y. Core CPI rose a tiny 0.1% M/M, but dropped to 1.7% Y/Y from 2.3% Y/Y in January. PCE inflation, the Fed’s favourite inflation gauge which is generally lower than CPI, will probably also move further away from the 2% target.
• May headline retail sales dropped 0.3% M/M (vs 0% M/M expected). Car sales and gasoline were the culprits, as core retail sales were flat (vs. 0.3% M/M expected). April sales were revised higher to 0.5% M/M from 0.3% M/M. We saw a similar picture for the control group (important for GDP calculation), with a flat May figure which was compensated by a strong upward revision to 0.6% M/M in April.
• A fall of 0.4% in wage growth in the three months to April represented the biggest loss of real earnings for UK households since 2014. Wages are failing to pick up despite a robust labour market. Unemployment fell by 50,000 between February and April, leaving the jobless rate at a 42-yr low of 4.6%, and the number of people in work climbed 109,000 to a record 32 million.
• EMU industrial output grew in April (0.5% M/M) and employment rose in the first quarter of the year (0.4% Q/Q) to reach a record high, in fresh signs of healthy growth of the bloc’s economy. In absolute terms, 154.8 million people were employed in EMU in Q1, surpassing the previous peak of Q1 2008.
• ECB Weidmann highlighted the risks of continuing extraordinarily expansive monetary policy for too long. According to Weidmann, sovereign bond purchases muddy the waters between monetary and fiscal policy. "This can lead to political pressure being exerted on the euro-system to maintain the very accommodative monetary policy for longer than appropriate from a price stability standpoint," Weidmann said
• The global oil glut is here to stay through 2017 as OPEC’s efforts to restrain petroleum production have hit a wall in the US, the IEA said in its closely watched monthly oil report. The world’s vast levels of stored oil, a proxy for the global oversupply, grew to 292 million barrels in April in industrialized nations, higher than the 5-yr average.

Rates

Softer US inflation and retail sales send bonds higher

Ahead of the FOMC decision, markets usually trade uneventful. Today’s session was exceptional, due to the release of weak US eco, data. For the third month in a row, inflation surprised on the downside and declined. Headline and core inflation are dropping further below the 2% target, which suggests that the (core) PCE deflators, the Fed inflation targets, which are structurally lower than CPI, will drop too. Some governors already showed concern about the direction of inflation and these figures only add to the argument. The expected rate hike today will probably pass, but more of these figures clearly question the Fed’s projected rate path and even the start of the balance sheet tapering which will normally be initiated later this year. The Bund auction was weak, but in line with recent average.

US Treasuries shot higher after the data, pushing yields substantially lower to key support. The monetary policy sensitive belly of the curve outperformed. In other markets, the dollar was heavily sold with main dollar supports under test. US (and European ) equities were higher ahead of the release, but are off the lows.

Later today, the FOMC renders its decisions. A 25 bps rate hike by the Fed is completely discounted, but markets’ expectations about the continuation of the tightening cycle are extremely low (even lower after today’s data releases). We expect the Fed to pencil in another rate hike this year and 3 hikes in 2018. The 2019 median forecast could be lowered slightly. Holding on to the blueprint of the rate path in combination with official communication about starting the BS run-off in H2 2017 should confirm last week’s technical bottoming out on US yield markets (failed tests 5-y (1.69%), 10-yr (2.17%) and 30-yr (2.82%) and could start a new up-leg in yields. Of course today’s data seam doubts about these expectations which we’ve put forward this morning. Yellen’s comments today will be even more important than usual.

At the time of writing, the German yield curve flattened with yield changes ranging from +1.1 bp (2-yr) to -4 bps (30-yr). The belly of the US yield curve shifts about 7.5 bps higher and the wings 6 bps. Spread narrowing on EMU bond markets continued with Spain and Italy narrowing 4/5 bps at the 10-yr tenor versus Germany and Portugal even 10 bps.

Currencies

Poor US data put dollar under pressure ahead of the Fed

Today, major dollar cross rates initially held tight ranges. However, the USD-lethargy was brutally interrupted after weaker than expected US retail sales and CPI. USD/JPY dropped from the 110 area to the 109.30 area. EUR/USD trades in the 1.1275 area, nearing the key 1.1300/66 resistance. The currency market is clearly positioned for a soft Fed. Will the Fed go in the direction of the market?

Overnight, Asian equities traded mixed despite yesterday’s WS rebound. China underperformed, despite Chinese data coming out close to expectations. USD/JPY held a tight range near 110. EUR/USD did go nowhere in the 1.12 area.

This morning in Europe, EUR/USD and USD/JPY stayed in a wait-and-see modus. EUR/USD was paralysed in the 1.12 area. USD/JPY profited slightly from a stronger equities, moving from the 110 to the 110.30 area.

In the US, usually investors are reluctant to react to data just hours before a Fed policy decision. However, both series again missed the consensus by a wide margin. The data added to uncertainty whether the Fed would be able to maintain its policy normalisation path. US yields nosedived and so did the dollar. EUR/USD jumped to the mid 1.1275 area. The recent top and the 1.1300/66 resistance are on the radar. USD/JPY slipped to the 109.25 area. The focus now turns the Fed policy decision, the dot plot and Yellen’s press conference. The (FX) market is positioned for a soft Fed assessment. Our working hypothesis was that the Fed wouldn’t give too much weight to recent softer data. In that scenario, the EUR/USD 1.1300/66 resistance looked quite tough. This hypothesis could be challenged if the market would hesitate about the Fed’s normalisation campaign. USD/JPY and the trade-weighted dollar are also nearing important support levels.

Poor wage data halt sterling rebound (against the euro)

This morning, the yesterday’s sterling rebound continued. EUR/GBP dropped to the 0.8766 area. Cable filled offers just below 1.28. The rebound was aborted by the publication of the UK labour data. The unemployment rate stabilized at 4.6%. Employment growth was slightly softer than expected but especially wage growth data posted again a big miss. Average weekly earnings declined from 2.3% Y/Y to 2.1% Y/Y (ex Bonus even from a downwardly revised 1.8% Y/Y to 1.7% Y/Y, 2.0% was expected). So, taking the May inflation jump into account, real earning are declining fast. The combination of high political and economic uncertainty and low wage inflation will probably will make the BoE prioritize growth over inflation when setting monetary policy. At the same time, UK PM May made no noticeable progress in finding support for its minority government. EUR/GBP reversed the early decline and returned to the 0.88 area. Cable dropped to 1.2725/40 area, but jumped back to the 1.28 area as the dollar was hammered after disappointing US data.