Disbelief

Oops. Inflation in the US came in hotter-than-expected in September, both on monthly and yearly basis. The headline inflation eased less than expected from 2.5% to 2.4%, while core inflation unexpectedly ticked higher from 3.2% to 3.3%. Nothing looked encouraging in that inflation report for the Federal Reserve (Fed) doves. Some investors found a little comfort in jump in the weekly jobless claims data released at the same time than the CPI report. That triggered a period of hesitation between those who wanted to believe that the Fed’s focus on the health of jobs market could continue even if inflation behaves undesirably. And interestingly, some Fed officials seemed alarmingly little concerned in the face of an uptick in inflation even before the effect of the first – and the jumbo rate cut – is felt. But Raphael Bostic said he’s open to skipping a rate cut. Indeed, if inflation picks up momentum, the Fed’s focus will shift back to containing it – even though it means a weaker jobs market and a slowdown for the US economy. That’s the basis of the economic theory.

The market reaction to yesterday’s US CPI data was mixed. The stock investors’ first reaction was hesitation. There has been an initial selloff, followed by some dipbuying, then a selloff again. At the end, the S&P500 ended the session 0.21% down – which is a surprisingly nice performance given that the combination of higher-than-expected inflation and uglier-than-expected jobs data is simply bad for growth prospects: it means that the Fed must deal with inflation first and let growth slow down while it gets prices under control. So, I am surprised that the S&P500 didn’t show a bigger reaction and even more surprised that the US futures are slightly in the positive this morning.

Due today, the core PPI is expected to print a jump in producer prices from 2.4% to 2.7% y-o-y. Hotter-than-expected figures should – at some point – break the back of the Fed doves.

In the bonds space, the US 2-year yield spiked above 4% post-US CPI but the rebound remained short-lived. The probability of a 25bp cut in the FOMC’s November meeting is slightly higher than no cut bets after the CPI data. There is room for less dovishness when traders get ready to see the truth.

As such, the US dollar index was bought then sold and bought and sold again yesterday to end the day near flat after yesterday’s hotter-than-expected inflation report. But the dollar bulls have all the reasons in the world to bet against the Fed doves as the Fed itself could have its back against a wall with the pretty strong jobs, and hotter-than-expected inflation data.

The EURUSD collapsed to 1.09 yesterday as, as opposed to the Fed, the European Central Bank (ECB) rate cut expectations are justified by a Eurozone inflation that fell below the ECB’s 2% target. The pair is better bid this morning but the price rallies are expected to see resistance near the 1.0980 level, the major 38.2% Fibonacci retracement that should keep the EURUSD in the bearish consolidation zone and encourage a further selloff toward the 200-DMA, at 1.0875. A higher-than-expected US PPI print today could back a deeper dive in the EURUSD before the weekly closing bell, and a broader strength of the US dollar against other peers as some components in the PPI report affect the PCE index that the Fed uses as its favourite gauge of inflation to decide what to do with their policy.

Big banks kick off earnings season

Either way, the bank earnings will steal a part of the investor attention to the earnings season today. JP Morgan and Wells Fargo will open the dance, Citi, Morgan Stanley, Goldman and Bank of America will report next week and provide some insights regarding the overall health of the economy. The US bank stocks have performed well this year, they are the second best performers among the S&P500 sub-sectors this year after technology as the Fed rate cuts got delayed to the Q3 while the economic growth remained resilient. Sure, the saving rates and the delinquencies rates rose, but that didn’t have a material impact so far… And if all goes well, the lower net interest income due to the upcoming Fed cuts will be compensated by improved economic activity and a faster loan and deposit growth, while a potential delay in Fed cut rates should keep the net interest income intact. As such, the bank investors have reason to believe that their bank stocks could extend their gains in both scenarios. Let’s see if the expectations match the reality on the field.

China, Mid East tensions keep Oil bulls alert

China will unveil more details about its fiscal stimulus plans on Saturday and their announcement should live up to high market expectations to prevent investors’ enthusiasm from entirely fading. The expectation is a 2 trillion yuan package, ten times the number pronounced by authorities earlier this week.

And tensions in the Middle East will likely keep investors tense into and during the weekend. The barrel of US crude jumped 3% yesterday on possibility that Israel could attack Iran’s oil and nuclear facilities. Short-term risks in oil remain tilted to upside.