US inflation data in the market purview

Markets

With next week's pivotal US inflation data looming, we're witnessing a stall in stock market momentum and an uptick in US Treasury yields. This shift comes amid murmurs of hawkish sentiment from Fed speak. Indeed the mind games intensify even further as investors cling to their rate cut hopes, more so with the Federal Reserve seemingly on the hunt for disinflationary signals.

As we approach the window where US inflation data comes into view those hawkish Federal Reserve noises and outsized earnings swoons like Disney's will be tougher to sweep under the rug. This is especially true given the steady run of inflation overshoots that have become a market reality, adding pressure on investors to reduce risk ahead of a potentially volatile week. Certainly, when we approach significant milestones such as the 5200 mark on the S&P 500 index, investors typically seek tangible evidence, or "proof in the pudding," to justify their buying decisions.

Meanwhile, Treasury 10-year yields surged, reaching the 4.50% mark, following a lacklustre response to the latest bond auction. However, traders appear hesitant to push the broader index higher or to acquire more bonds until they receive a fresh update on inflation. The outcome shouldn't necessarily be interpreted as a hawkish surprise. It simply reflects the point in the curve after a steep rally with the market still cautious about inflation while awaiting further developments.

If stock market operators are heavily relying on interest rates as their playbook, then it's reasonable to consider buying the dip as a prudent move. Looking ahead to the remainder of the year, it's plausible that 10-year yields will hover closer to 4% than 5%.

Since the return of inflation in the first quarter, we have firmly believed that it is mainly due to seasonal factors. This belief has kept us committed to the idea of three rate cuts, despite the market being more inclined towards just one.

Looking ahead to a potential September cut, the path forward hinges on core inflation prints, especially the PCE, and the continuation of soft NFP prints. Survey data strongly suggest that this scenario is not only possible but increasingly likely.

My primary concern lies in the potential transformation of the "bad news is good news" narrative into "bad news is bad," particularly regarding the US consumer. This apprehension is prompting me to take profits, particularly against the backdrop of top-side knock-in orders.

There's an age-old question: Has the spending spree of the American consumer finally reached its limit? For years, betting against the American consumer has been akin to chasing fool's gold in the macroeconomic landscape. Despite challenging circumstances, Americans have demonstrated a proclivity for spending. However, cracks are beginning to show. Rising delinquencies across various credit categories, coupled with soaring credit card debt and interest rates, suggest that this delicate balance may be nearing a breaking point.

Asia open

Asian markets are poised for a lacklustre start on Thursday, influenced by a mix of factors including varied U.S. corporate earnings, a strengthening dollar, and a gradual rise in U.S. bond yields, which collectively diminish investors' appetite for riskier assets.

The Japanese yen has once again become the focus of attention due to its recent decline, despite warnings from Tokyo on Wednesday they have been ignored so far. This has supported the US dollar which could very well be on a collision course with 156. However, with BoJ Ueada’s definitive upgrade in the communication that an unruly FX move can and likely will prompt a policy response from the Bank of Japan, hedge funds might be reluctant to test those waters ahead of next week's US inflation data.

On the economic front, there are several potentially market-moving indicators and events scheduled for Thursday, including Chinese trade data and a monetary policy decision from Malaysia although the global focus has already gravitated to next week’s US inflation data

Forex markets

The recent interest rate cut in Sweden highlighted the widening gap between the policy paths of European central banks and the Federal Reserve, potentially paving the way for rate cuts in June by the European Central Bank (ECB) and the Bank of England (BOE). Despite anticipated softening economic data in the US, the possibility of policy disparities has given a boost to the US dollar

However, while these developments may seem influential on the surface, it's essential to recognize that the primary drivers of the US dollar lie within US economic data and Federal Reserve actions. While international monetary policy decisions can impact currency markets, the health of the US economy and the Fed's decisions hold the greatest sway over the dollar's trajectory.

The expectation is the dollar will trend downwards as the market responds to softer US economic data and adjusts its expectations for the Federal Reserve's reaction function to a more dovish outlook.

Oil markets

Oil prices managed to recover some ground spurred by the release of the Energy Information Administration's (EIA) Weekly Petroleum Status Report.

According to the EIA, commercial crude oil inventories in the U.S. experienced a decline of 1.4 million barrels (bbl) in the week ending May 3. This contrasts with the 509,000 bbl build reported by the American Petroleum Institute on Tuesday. Meanwhile, both gasoline and distillate fuel inventories saw increases as refining activity ramped up in anticipation of the summer driving season, with gasoline stocks growing by 900,000 bbls and distillate fuel stocks by 600,000 bbls last week.

Simultaneously, the dominance of the dollar persists, diminishing the appeal of commodities like oil for foreign currency buyers.