UK Economy Contracts, US PPI Slows, and Global Markets Respond
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The fever is breaking.
By Ipek Ozkardeskaya, Senior Analyst | Swissquote Bank
US inflation eased to 3%. It's still not the 2% targeted by the Federal Reserve (Fed), but it's approaching. Core inflation on the other hand eased more than expected to 4.8%. That's still more than twice the Fed's 2% policy target, but again, the US inflation numbers are clearly on the right path, the services inflation including shelter costs is easing, and all this is good news for breaking the Fed hawks back amid mounting tension over the past few weeks.
There hasn't been much change in the expectation of another 25bp hike at the Fed's next policy meeting, which is now given a more than 90% chance, but the expectation for a September hike fell, the US 2-year dropped to 4.70% after the CPI data, while the 10-year yield fell to 3.85%.
One big question is: if inflation is easing at a – let's say - pleasing speed, why would the Fed bother raising the interest rates more? Wouldn't it be better to just wait and see where inflation is headed?
Well yes, but the Fed officials certainly continue thinking that 4.8% is still too hot, and that the risk of a U-turn in inflation expectations, and inflation is still to be carefully managed. Because the favourable base effect due to energy prices will gently start fading away in the coming months and the result on inflation will be less appetizing. Then the rising energy prices today could fuel price dynamics again in the coming months, and if China manages to fuel growth thanks to ample monetary and fiscal stimulus, the impact on global inflation could be felt. And if you listen to Richmond Fed's Thomas Barkin, that's exactly what comes out: 'if you back off too soon, inflation comes back stronger'. But the possibility of two more rate hikes following the most aggressive hiking cycle from the Fed starts looking a bit stretched with the actual data. Due to release today, the US producer price inflation is expected to have fallen to the lowest levels since the pandemic, we could even see some deflation.
And a potential Chinese boost to inflation looks much less threatening today compared to a couple of months ago. Chinese exports plunged 12.4% in June, worse than a 7.5% drop printed in May and worse than the market forecasts of a 9.5% decline. The June decline in Chinese exports marked the steepest fall in sales since February 2020. Deteriorating foreign demand on the back of high inflation and rising interest rates continued taking a toll on Chinese trade numbers. In the meantime, imports fell 6.8%, the fourth straight month of decrease due to persistently weak domestic demand.
China will likely recover at some point, but we will unlikely see the Chinese growth put a severe pressure on commodity markets. That's one good news for inflation watchers. The other one is that the US student loan repayments will resume from October, and that should act as a restrictive fiscal action, and help the Fed tame inflation. Therefore, even though there could be an uptick in inflation figures in the coming months, we will unlikely see inflation spike back above 4-5% again. But we will also unlikely to see it fall to 2% easily.
