Is A 0.3% Miss On Headline CPI Really Worth The 77 Bp Rise In Fed Funds Rates? |

Better than expected Chinese data and an unscheduled ECB meeting were the highlights ahead of the North American session that features the May US report and other high frequency data before the outcome of the .

Asia Pacific equities outside of and fell. Europe’s was up almost 1% as it tried to snap a six-day slide. US futures were posting modest gains.

Bond markets in Europe and the US were rallying. The ECB meeting spurred a dramatic narrowing of the peripheral premium. The US yield was off 8 bp to about 3.4%.

was weaker against all the major currencies. The led with almost a 1% gain. Most emerging market currencies were also firmer.

The Hong Kong Monetary Authority intervened selling about $1.2 bln for to defend the peg. found support ahead of $1800 yesterday and was near $1825 in Europe.

July peaked yesterday near $123.70 and was offered below $117.50 at time of writing. US stabilized after falling 16.5% yesterday. was up almost 2.6% to extend yesterday’s 15.5% surge.

Better than expected Chinese industrial output figures failed to provide much support of prices, which fell around 2.8% to extend the losing streak to the fifth consecutive session. was slightly higher for the first time in five sessions. July was off about 0.5% after a 2% fall yesterday.

Asia Pacific

Today’s data dump showed that the Chinese economy began recovering last month from the disruption caused by the zero-COVID policy.  rose 0.7% year-over-year rather than contract by 0.9% as economists (median forecast in Bloomberg’ survey) expected. In April, it had fallen by 2.9%.

were off 6.7% year-over-year in May after dropping 11.1% in April. This was also better than expected. Surveyed eased to 5.9% from 6.1%. Economists had expected an unchanged report.

and property investment disappointed. Fixed asset investment rose 6.2% this year through May compared to a year ago, slowing from the 6.8% rise in April. Property investment was off 4% in May after falling 2.7% in the first four months.

China also left its one-year medium-term lending facility at 2.85%, where it has stood since the 10 bp cut in January. Some observers looked for a small cut on ideas that consumer price pressure was low and producer prices have continued to ease, while the economy looks off course to reach 5.5% growth target.

Still, the PBOC has been reluctant to use monetary policy much so far preferring instead to use regulatory power, fiscal incentives, guidance, and suasion. The PBOC also rolled over in full CNY200 bln (~$30 bln) in maturing loans.

Australia’s bond yield soared 24.5 bp today to almost 4.2%. The new government made good on its campaign promise to hike the minimum wage.

During the campaign, Prime Minister Albanese advocated matching the 5.1% increase in consumer prices in the first quarter. The President of the Fair Work Commission announced a 5.2% increase starting next month. The minimum wage will increase by A$40 to A$812.6 a week. The new hourly rate is A$21.38. The 5.2% rise is twice the of Q1 (2.4%).

The decision came after a hawkish speech by RBA Governor Lowe, who warned that inflation could hit 7% this year. Lowe said it was “reasonable” to expect rates will rise to 2.5% from 0.85% now.

The cash rate futures saw it reaching that in three meetings (July, August, and September). The futures market had 56 bp hike next month (July 5), while the swaps market was closer to 75 bp.

The edged up to a new multi-year high late yesterday to reach almost JPY135.50. The upticks were extended marginally to JPY135.60 in early Asia turnover before sellers emerged. The greenback was driven to nearly JPY134.50 where it stabilized. Yesterday’s low was slightly below JPY133.90. The dollar has not taken out the previous day’s lows since May 26.

The Australian dollar recovered from the $0.6850 area approached yesterday. Recall that the two-year low set in mid-May was near $0.6830. The session highs were recorded in the European morning near $0.6940. Yesterday’s high was around $0.6970. A move above $0.7000 would stabilize the technical tone.

The greenback slipped to a three-day low against the by CNY6.7115. It peaked yesterday closer to CNY6.7610. The dollar’s reference rate was set at CNY6.7518. The median projection in Bloomberg’s survey was CNY6.7524. In four of the past five sessions, the dollar’s reference rate was below the survey median.


The ECB held an unscheduled meeting to ostensibly talk about market developments. The key market development was not the ‘s dip below $1.04 yesterday, but the dramatic increase in rates, and more importantly the widening of the peripheral spreads over Germany. The “fragmentation” dilutes the effectiveness of the ECB’s monetary policy.

While the ECB ostensibly has a single mandate, to achieve it the ECB recognized it must contain the divergence of interest rates among its members. The Italian over Germany widened to a two-year high near 225 bp yesterday, but to be sure, it was not just Italy. Spain’s rose to 136 bp yesterday, also its highest level since the chaos when the pandemic struck.

It was not clear what the ECB can do. We noted that as a compromise last year when some advocated a new mechanism to contain the “fragmentation.” It was to give the ECB greater flexibility to reinvest maturing proceeds. We have also argued that a tool already exists (European Stabilization Mechanism) but the support is tied to conditionality.

Market talk suggested a more formal agreement on reinvestment of the maturing issues under the Pandemic Emergency Purchase Program can be forthcoming. However, if that was all it was, the markets will likely be disappointed and unwind the euro and bond market gains.

ECB’s Schnabel, who oversees the central bank’s market operations, said commitment to resist fragmentation has no limits. A disappointed market may be tempted to test the resolve.

There were a few other developments to note. First, the EMU aggregated April figures were in line with expectations. The 0.4% rise followed an upward revision to the March series to show a 1.4% contraction rather than loss of 1.8%.

Second, the eurozone reported a record of 31.7 bln euros in April, more than twice what economists (median, Bloomberg survey) anticipated. Rising energy prices seemed like the major driver.

Third, much to the chagrin of the UK government, the European Court of Human Rights blocked the first flight that was going to deport refugees to Rwanda.

News of the emergency ECB meeting helped lift the euro, which for the third session found bids near $1.04. The euro traded above $1.05 in the European morning, though was unable to take out the week’s high set on Monday slightly shy of $1.0525. The (38.2%) retracement of the euro’s decline since the US CPI figures was closer to $1.0540. There are options for almost 610 mln euro that expire today at $1.05. We suspected that if the high was not in place on the ECB news, it was close, and we were concerned that the markets may be disappointed with the results.

closed below $1.20 for the first time since March 2020. It was firmer today and did not take out yesterday’s low (~$1.1935). It rose to almost $1.21 but this too looked like the extent of the move or nearly so. The Bank of England tomorrow, and the swaps market had a little less than a 1-in-3 chance of a 50 bp move discounted. 


The market’s reaction to a 0.3% miss on the (vs. Bloomberg survey median forecast) and 0.1% on the rate (which still eased by 0.2% to 6.0%) was violent, triggering dislocations throughout the credit market. The implied yield of the December Fed funds futures was around 2.75% before the CPI report.

The implied yield has risen 77 bp in the past three sessions and settled yesterday at about 3.55%. The increased expectation for the overnight rate can account for the 45 bp increase in the 10-year yield. Doesn’t this seem a bit much? 

The core rate did ease for the second consecutive month, and the reason the core is discussed is not simply because it excludes volatile components, or that it is widely recognized that monetary policy has little impact on food or energy prices, but because over time, headline inflation converges to core inflation, not the other way around.

Before entering the quiet period ahead of this week’s FOMC meeting, a solid consensus appeared to emerge for a 50 bp hike in June and July, with the usual caveats the preserved ultimate flexibility. The Fed funds futures market had nearly fully discounted a 75 bp hike today and in July before another 50 bp move in September. The swaps market had the terminal Fed funds rate at 4.17% now, up nearly 70 bp since the CPI report.

Monetary policy impacts come with the famous variable lags and leads. Should we really be convinced that one high frequency measure of inflation that it does not target would so dramatically change the course of monetary policy?

Arguably, a 75 bp hike that the market had discounted, risks injecting more volatility into the disrupted Treasury market and may alter its reactionary function.

Mr. Market was trying to deliver a fait accompli to the central bank, which there seemed to be universal recognition that it was behind the inflation curve. It hiked market rates sharply and the precipitous drop in equities pointed to the tightening of financial conditions, as if the Fed had already tightened.

If the Fed were to hike by only 50 today, would the financial conditions ease? A 50 bp cut could almost seem dovish especially for a market that tended to see Powell as dovish even though between the rate hikes and the balance sheet, the Fed has launched the most aggressive tightening cycle in a generation.

Many observers began with an unspoken premise that the Fed had lost its anti-inflation credibility, but maybe this was a prejudice. The jump in rates was in expectation of what the Fed will do, and that was to stabilize prices even if it boosted the chances of a recession.

Was this anti-inflation cred? The FOMC , the up-dated (the dot plot), and offer many channels through which the Fed could underscore its commitment to its stable price mandate,

We say that that Fed will tighten policy until something breaks. The University of Michigan’s preliminary June results showed a rise in but also readings that have been associated with a recession in the past.

With rising about 6%, it was reasonable to expect some slowing in the housing market. Before the FOMC meeting concludes, investors and policy makers will see the weekly mortgage market activity index, which has fallen for the past four week. The , the , and / prices may draw some interest, but the real focus is elsewhere.

May retail sales will have been held back by disappointing auto sales, though a broad slowing was expected. The components which GDP models picked up from different time series, like auto sales, gasoline, food services, and building materials, can be excluded.

The remaining measure rose 1.1% in March and 1.0% in April. It was expected (median Bloomberg survey) at 0.3% last month. Remember retail sales is reported in nominal terms, which means that rising prices inflate the numbers.

Over the last five sessions, the US dollar jumped about a little more than 3.6% against the to reach CAD1.2975 yesterday. It was the highest level in a month. Today was the first session in five that the greenback may not take out the previous day’s high, but do not bet on it. The flattish consolidation was not inspiring, and the Loonie was the poorest performing major currency through the European morning with a gain of less than 0.05%. The general risk environment was the most important near-term driver, so watch the . The Canadian premium, which fell from 30 bp last week to less than 3 bp yesterday widened back to around 12 bp today.

In the four sessions through yesterday, the greenback rose almost 6% against the to reach MXN20.69. It too was consolidating today in a narrow range mostly above MXN20.53. The central bank was seen hiking 75 bp next week, but there was a risk of a 100 bp move.

Brazil’s central bank was expected to the Selic rate 50 bp to 13.25% later today. The central bank was getting close to the peak, but the swaps market saw the risk of another 100 bp before it was over. The next meeting is Aug. 3. Year-to-date, the has appreciated almost 9% against the US dollar, the best performing EM currency (excluding Russia). However, so far in June, the real has been the worst performer, falling about 7.5%.

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