Its inflation Jim, but not as we know it

Last night’s US Consumer Price Inflation data continued highlighting that inflation is alive and well. Looking at the MoM data, my preferred measure for the direction of travel, rather than the heavily distorted YoY measures, revealed another month of sharp rise by headline and core inflation readings. Headline inflation rose by 0.60% versus 0.40% expected. Core inflation rose by 0.70%, also versus 0.40% expected.

Applying some Vulcan logic to the numbers, one would have expected US yields and the greenback to rise and equities to fall. Instead, precisely the opposite happened, leaving many disappointed inflationistas scratching their heads, including those with pointy ears mumbling about how illogical humans are.

US long-dated bond yields had been falling since last Friday's Non-Farm Payroll miss, suggesting that the market's path of least resistance was to follow the Federal Reserve transitory inflation path. A course that conveniently ties in with underlying the financial world's positioning since March 2020; that is, buy everything you can except the US Dollar. Financial markets have long raised a selective use of facts to an art form.

Although the US inflation measures rose once again and slightly above forecast, the actual increases were less than those recorded in April. But, with the thoughts above in mind, that was all the street needed to return to its buy-everything happy place. Demand for US treasuries remains insatiable, high global savings rate are still looking for a home in a zero percent world, and all that central bank money is still flooding the system. The inflation data needed to either fall dramatically or print much higher than last month to move the needle. In the end, it came in at no man's land levels triggering a reversion to the mean behaviourally for financial markets.

Next week's FOMC meeting will now be a non-event, with the Fed knowing the market is happy to sign up to the transitory narrative. President Biden's infrastructure and build back better wish list looks in big trouble in the US Senate as well. A much slimmed down version would mean less US government borrowing in the future. Happy days for the buy everything trade. The only thing I can think of that would move the needle would be a "t-word" mention next week, unlikely, or a two million-plus Non-Farm Payrolls next month, also unlikely.

So, sit back and keep buying everything

Elsewhere in Asia, the data calendar is thin on the ground today. South Korean Import and Export Prices showed sharp rises YoY but given its comparison to the depths of the pandemic a year ago, the increases will surprise nobody. Malaysia and India should also show galactic-level increases in Industrial Production later today, but the same distortion from YoY comparisons apply. Both are grappling with pandemic issues right now, and a negative impact on shorter-term data releases will be more apparent in the weeks ahead.

Early equity rally fades in Asia

With Wall Street in transitory inflation rather than sticky inflation mode overnight, equity markets moved higher. The S&P 500 finished 0.47% higher, with the Nasdaq jumping 0.78%, while the Dow Jones managed only a 0.04% rise. In addition, US yields sank once again after the inflation data, helping the rally along with index futures in Asia ever so slightly in the green.

Asian equity markets rallied initially but quickly ran out of momentum, with much of the region slipping back to unchanged or slightly down. Regional investors appear content to continue reducing exposure ahead of the weekend, and there could be some concerns that the G-7 meeting in progress at the moment could spring some surprises.

The Nikkei 225 is now down 0.10% after rallying earlier, although the Kospi remains in positive territory, up 0.40%. In China, the Shanghai Composite is 0.25% lower while the CSI 300 has fallen 0.60%, although the Hang Seng has risen 0.50%. Singapore is 0.10% higher, while Kuala Lumpur has declined 0.30%. Jakarta is down 0.30%, but Taipei has climbed by 0.35%. Australian markets have given back some early gains, but both the ASX 200 and All Ordinaries remain 0.25% higher today.

Although upside momentum has quickly waned in Asia, the benign reaction by US markets to the inflation data is providing some support. That should be enough to lift European markets slightly this afternoon, although, with a quiet data calendar, both Europe and Wall Street are likely to finish the week with choppy range trading driven by headline risk.

Currency markets remain in an induced coma

Currency markets remain comatose, registering barely any reaction to the US inflation data overnight. The dollar index eased 0.08% to 90.06 and has dropped another 0.09% to 89.98 in Asia. The fall in US yields has had zero impact on the US Dollar this week, suggesting that much of the buying pushing US yields lower is offshore, balancing out the negative flows from narrowing rate differentials.

That has left EUR/USD and GBP/USD almost unchanged at 1.2188 and 1.4177 after the ECB policy decision ran exactly to an unchanged script overnight. On the other hand, USD/JPY has followed US yields lower to 109.40 and failure of 109.20 could open up deeper losses to 108.50 next week, especially if US yields remain at multi-month lows. 

With the major currencies in a holding pattern, the USD/CNY is also rangebound, drifting 0.10% lower to 6.3865 today after a neutral PBOC fix and liquidity operation. Asian currencies have rallied modestly today, but with the dollar index seemingly glued to the 90.00 area, at best, we can expect more range trading from regional currencies.

Next week's FOMC meeting is the next major risk point for currency markets. Given that they will loudly proclaim the transitory inflation mantra and keep their foot on the monetary pedal, more US Dollar weakness across the board will likely be the path of least resistance next week.

Oil markets in range-trade mode to end the week

Oil prices finished modestly higher overnight after the US inflation data caused both contracts to spike lower initially. With markets seemingly comfortable with the Fed's transitory narrative, oil quickly recovered. Brent crude finishing 0.47% higher at $72.40 a barrel, and WTI closing 0.50% higher at $70.10 a barrel.

News that Saudi Arabia has unwound all its voluntary production cuts are circulating in Asia today, and that appears to have temporarily pushed oil prices lower. As a result, Brent crude has fallen 0.25% to $72.15, and WTI has eased 0.15% to $69.93 a barrel. The reaction is modest, though, and if anything, the price action is bullish. It suggests that the physical market has absorbed extra Saudi production with ease and that demand globally is robust and climbing.

Barring any G-7 surprises and an unlikely US Dollar rally, oil should resume its climb next week. Only a retreat by Brent crude through $70.00, or $68.00 a barrel for WTI, endangers the rally. Otherwise, Brent crude should target $75.00 and WTI $73.00 a barrel in the week ahead.

Gold remains mid-range

Like oil, gold spiked lower on the initial US inflation releases overnight, briefly falling below $1880.00 an ounce. However, as it became clear that bond markets were unmoved by the data, gold quickly unwound those losses and finished the session 0.50% higher at $1898.50 an ounce.

With US inflation fears consigned to the dustbin for another month, gold has modestly higher in Asia, reclaiming $1900.00 an ounce, dead-centre of the$1880.00 to $1920.00 trading range I expected to dominate the week. The FOMC meeting next week is now likely to be a non-event, and barring a sharp rise in the US Dollar, gold looks set to test resistance at $1920.00 an ounce early next week, as the asset price appreciation trade gains new momentum.

Only a fall through $1860.00 an ounce delays more gains by gold now, and a daily close above $1920.00 signals more gains to $1960.00 an ounce.