Soft US CPI Boosts Reflation Trade

I don’t know for the Federal Reserve (Fed) but investors definitely got to the evidence that inflation is on a right path to justify a Fed rate cut sooner rather than later yesterday after the latest CPI report printed a slower-than-expected figures both for headline and core inflation, both on a monthly and on a yearly basis. The US 2-year yield fell by another 10bp chunk to around 4.50% and the 10-year yield tipped a toe below 4.17% before bouncing back above the 4.20% mark. Activity on Fed funds futures showed that the probability of a September rate cut soared up to 95% and is holding near 92.5% this morning, while this probability was less than 75% at the same time yesterday morning. The US dollar index sank shortly below its 200-DMA. From a technical perspective, the index is still in the bullish trend, above 104.20 – the major 38.2% Fibonacci retracement on this year’s rebound, yet we now have a stronger case building for a sustainably decline below this level.

The sharp dollar selloff sent the US dollar meaningfully higher against most currencies but the Japanese yen particularly attracted attention after the USDJPY tanked from near 162 to below 159 level in a single move. The move sparked speculation that the Bank of Japan (BoJ) may have stepped in and took the opportunity to exacerbate the negative move. Some news outlet backed the rumours while the BoJ officials kept silent. Not knowing whether yesterday’s yen purchases were or were not fueled by the BoJ makes intervention significantly more effective as traders simply don’t know if – by buying the dip – they are betting against the BoJ, which has only limited sources to make such interventions, or they are betting against thousands of buyers who have the power to overhaul the market. As a result, we don’t know, but the USDJPY is trading below 160 this morning.

In the UK, the pound was already bid yesterday morning after stronger-than-expected growth data helped traders scale back the expectation of an August cut from 70% to a coin toss. Combined with rising hawkish voices at the Bank of England (BoE), waning political risks and softening US dollar, we could see Cable make an attempt on the 1.30 level. But the fact that the BoE hawks cry louder doesn’t mean that the doves are not around…

Across the Channel, the EURUSD advanced to 1.09 yesterday. The single currency got a further support from the French finance minister Bruno Le Maire’s pressing with planned spending cuts to reassure the EU and the markets that France will comply with the EU rules and not let the debt explode following a government change, while the Bank of France Chief Francois Villeroy warned against increasing the government debt and taxes for companies. The fiscal and monetary policymakers joint efforts seem to be paying off with the French 10-year yield back to levels when Macron had called for the snap election and the CAC 40 is again testing the 200-DMA offers to the upside on lower yields and on a revived reflation trade on rising Fed cut expectations.

Interestingly, the S&P500 and Nasdaq fell sharply yesterday after the US CPI data. The sharp rise in Fed rate cut bets and falling yields looked like they didn’t give support to the major US indices, but they did. The S&P500’s equal weight index jumped 1.20%. Almost 400 stocks within the S&P500 gained yesterday, all sectors gained except for technology – and consumer staples as it was dragged down by Amazon, but most stocks in the S&P500 cheered the news. The Russell 2000 soared more than 3.5% to this year’s peak level that was reached by the end of March. Oil gained, gold jumped past the $2400 level as lower yields decreased the opportunity cost of holding the non-interest bearing metal while SPDR’s metals & mining ETF jumped 2.74%. So the flight from Big Technology to other sectors, the reflation trade, was big like a mountain at yesterday’s trading session. But it also came as a proof that, no matter how hard the other sectors rally, if the bleeding in Big Tech stocks is not contained, the major indices will suffer.

Inside Tech, Nvidia lost more than 5.5% as investors left the safety of Big Tech which are rate-proof thanks to AI, MAMAA stocks fell 2.77% while Tesla dived almost 8.5% as the selloff was amplified by the news that the company will delay revealing details on its robotaxi from August to October and use the additional weeks to build additional prototypes. It sounded like the prototypes that they have in hand are not good enough to keep investors dreaming. Note that, Tesla’s stock price rallied 11-day in a row after Elon Musk pointed at August 8th robotaxi reveal, let’s see how many days of selloff the delay will cause.

Today, attention shifts to earnings. The US big banks will open the dance today. Shares of big US big banks outperformed the S&P500 this year. But the Q2 results may look mixed as the interest rate environment wasn’t favourable due to rise in yields, the net interest income may have remained limited due to sluggish loan growth, the non interest revenues were probably mixed due to slowing economic activity and credit is a place to watch given the fears around the commercial real estate but investors could look past the rate-related worries as the Fed is now expected to announce the first rate cut as early as September and cut three times before the year ends.