Ouch. Released Friday, the US CPI data unexpectedly advanced to 8.6% in May. The data slashed hope that inflation had peaked, and revived the hawkish expectations that the Federal Reserve (Fed) should get more aggressive if it wants to take control of inflation.
Plus, the University of Michigan’s consumer confidence index fell to the lowest level since the data started in 1978, which gave just another hit to investors who were already knocked out by the inflation figure.
The unexpected U-turn in US inflation number also removed the 3% speed bump on the US 10-year yield. The 10-year yield shot up to 3.20% this morning, and the 2-year yield hit 3.19%. We shall see a further selloff in the US short and long-term treasuries on revived hawkish Fed expectations into Wednesday’s FOMC decision.
On Wednesday, the FOMC is expected to raise the interest rates by another 50 bps, yet the possibility of a 75-bp hike is now being priced in. Before inflation data, activity on Fed funds futures assessed around 5% chance for a 75bp hike at this week’s meeting. Now, they price a 23% chance of a 75bp hike.
More importantly, the chance of a 75bp hike in July meeting is now more than 50%, and the market even gives a 14% chance for a 100bp hike. This is how hawkish the Fed expectations got following the Friday’s unfortunate CPI read.
A major hit to equities, and to Bitcoin
The S&P500 took an ugly dive after the US CPI data revived hawkish Fed expectations. The index lost near 2.90% on Friday, as Nasdaq lost more than 3.5%. Bitcoin tumbled to $25K.
The data was so ugly that even the American crude slipped below the $120 per barrel, on fear that the Fed may not have a choice but to push the US economy into recession to tame inflation. The Atlanta Fed’s GDPNow projection is at 0.9% for the second quarter growth, down from 1.3% a week ago. The next release is on Wednesday, and won’t look any better.
US dollar up
The US dollar is roaring again, with the dollar index trading at 104.50 at the time of writing. All majors are down against the greenback, starting with the euro which fell below the 1.05 mark this morning against the US dollar.
The dollar-yen jumped above the 135 mark for the first time in 20 years. Cable fell below the 1.23 level, and the Aussie-dollar is about to slip below the 70 cents level.
There is little chance we see the US dollar soften before the FOMC decision this week, as not many investors have the guts to swim against such a strong tide, and such a strong reality!
The latest hit on the EURUSD will likely call for more aggressive action from the European Central Bank (ECB) to keep up with the Fed’s pace of tightening. Christine Lagarde made clear that she won’t conduct a catch-up policy with the Fed, nor the others. But the truth is, when the dollar becomes more expensive, many USD-denominated goods that Europeans import – starting with energy, become more expensive and boost inflation.
But in the short run, the hawkish shift in Fed expectations will likely continue weighing on single currency, until the ECB expectations catch up. The next natural target for euro bears stands at 1.0350, May support.
