ECB meets as Fed doves wave goodbye to jumbo cut

The latest US CPI data, and the reaction to data was mixed on Wednesday. The good news is that the headline inflation fell from 2.9% to 2.5% in August, and sank significantly below the 3% level where it was resisting since last summer. The drop in food and energy prices helped easing pressure in the headline figure. But core inflation – which excludes volatile food and energy prices – came in line with the expectations on a yearly basis, and slightly higher-than-expected on a monthly basis. Cost of housing and travel were  responsible for the stickiness in core inflation.

While the retreat in food prices is the continuation of the post-pandemic supply chain improvement story, and easing in energy prices is due to global geopolitical and economic factors, the stickiness in housing remains an issue that the Federal Reserve (Fed) must address with its rate policy. Therefore, yesterday’s data came to wave goodbye to the 50bp cut hopes at next week’s FOMC meeting. The probability of a 50bp cut melted to 13%, pulling the probability of a 100bp cut this year down with it.

The US yields fell and the US dollar rebounded. Equities first slid on moodiness that the Fed would cut less than projected before the CPI data release then rebounded on optimism that if the Fed cuts less it’s because economy is doing relatively fine. The S&P500 gained 1% and closed the session above its 50-DMA. The Dow Jones and the Russell 2000 gained around 0.30%. Technology stocks led gains leading to a more than 2% jump in Nasdaq 100, but the energy sector remained under pressure despite a rebound in oil prices after Hurricane Francine ran over key oil production zones in the Gulf of Mexico - that produces around 15-17% of the US total production - and where oil producers had to shut around 25% of their operations.

But we know that it will take more than a hurricane or a war in the Middle East to push oil prices sustainably higher in the foreseeable future. The demand concerns are growing, OPEC turns cautious, and Citi goes a step further, stating that 'there’s no room for any more barrels' in the market. They argue that not only should the cartel avoid increasing production, but it must also cut an additional one million barrels per day throughout 2025 to balance the market."

Nvidia’s has another problem

High demand... Nvidia’s CEO Jensen Huang said yesterday that the demand for its advanced chips is ‘so great’ that customers are frustrated if they don’t get their chips fast enough. ‘Everyone wants to be first and everyone wants to be most’ he said – first-world problems. His words gave a boost to Nvidia, and the stock rallied more than 8% yesterday, defying the AI fatigue. VanEck’s semiconductor ETF jumped more than 5%.

EUR/USD tests 1.1000 ahead of ECB decision

The US dollar jumped and extended gains in Asia this morning. The USDJPY rebounded after having tested the 140 waters, Cable flirted with the 1.30 support – as British growth stagnated for the second month in a row, and the EURUSD tested the 1.10 level.

The European Central Bank (ECB) will meet and most likely deliver its second 25bp cut later today. A 25bp cut is fully baked in the market prices, but there is room to act on what comes next. The Eurozone economies have been slowing, Germany is having hard time keeping its head above water, the right-wing parties are surging (even in Germany and France), no one sees the end of the tunnel in the Ukrainian war, and even China is not there to help the European luxury brands afloat.

In this gloomy context, some ECB members will be tempted to cut more than the 50bp baked in the market prices for this year, but some members will remain cautious pointing at the risk of inflation uptick. Therefore, Lagarde’s post-meeting presser will show the direction the euro will take from here. If Lagarde sounds like she and her colleagues remain concerned about the inflation risks, the EURUSD could find support near the 1.10 level and make another attempt on the 1.12 in the coming weeks. But if she shows growing concerns about the gloomy economic outlook, it will be the right time and the right reason for the EURUSD to return below the 1.10 mark. The economic and political setup have the potential to tilt expectations toward a series of three 25bp cuts starting from today. The latter would require a dovish adjustment to ECB expectations and the euro’s valuation.