Hotter-than-expected inflation will likely call for caution at next week’s FOMC meeting

Inflation in the US accelerated, not only in terms of monthly headline figure but everywhere, both core and headline, and both yearly and monthly figures came in hotter-than-expected. While gasoline prices counted among the major drivers of monthly inflation, shelter, electricity, used cars, air travel and clothes remained the major drivers of inflation on a yearly basis. That was not an encouraging CPI read. The US 2-year yield spiked past 4.60% on fear that the Federal Reserve (Fed) may not be able to cut the rates as soon as we think it will, and the 10-year advanced to 4.17% after the sale of a $39 billion worth of 10-year notes. The US dollar index made an attempt past the 103 level, and major currencies retreated against a broadly stronger greenback on softer dovish Fed expectations. The EURUSD tested the 1.09 level and gold fell to $2150 per ounce.

Key takeaway: Hotter-than-expected inflation will likely call for caution at next week’s FOMC meeting and get the Fed members to sound cautious about the timing and the number of rate cuts that they have in mind for this year. Happily, we don’t need to speculate much as the new dot plot is due as soon as next week. For now, the June cut expectation remains the base-case scenario – with a slightly lower 66% assessed to it after yesterday’s inflation update, and the Fed is expected to cut three times before the end of the year. But don’t dream rosy, the Fed members will probably sound cautious about the risk of inflation uptick.

Big caps can’t care less

Stock markets shrugged off the bad vibes from the unideal CPI data in a record time. The S&P500 fell as a kneejerk reaction to a hotter-than-expected inflation data but losses remained very short-lived, and the index advanced to a fresh record instead on narrative that, yes, inflation was hotter-than-expected, but it could’ve been worse.

Of course, if we function that way, we don’t need data anymore. So let’s admit that yesterday's stock market reaction to the data was unusual and irrational. The bullish trend is too strong to let go of and FOMO – fear of missing out - the AI rally is the major driver of the big-cap stocks right now.

On the other hand, inflation is not necessarily bad news for AI-related stocks. Higher inflation coupled with decreased pricing power for companies means stronger efforts to cut costs. And there is nothing better than turning to AI to cut costs effectively without necessarily giving up productivity. In this context, AI could be a hedge against an extended period of above-target inflation. But does that justify the 7% jump in Nvidia’s stock price yesterday?

BoE doves reassured

Sterling fell against the dollar as softer-than-expected jobs data in the UK reassured the Bank of England (BoE) doves and boosted the expectation of rate cuts this year to almost three following the data. Cable fell below 1.2750 yesterday but the pair has rebounded since and is ready to test the 1.28 resistance this morning as the BoE is not in a rush to start cutting rates either. Released this morning, GDP numbers came in line with expectations while construction output rose more than expected. The positive data should temper the pound selloff.

Wages, wages

In Japan, all eyes are on wages negotiations as many Japanese unions disclose their pay deals with employers this week. Yen traders are closely watching the news as any pickup in wages should boost inflation expectations and get the Bank of Japan (BoJ) to exit the negative rates sooner rather than later. So far, it seems that big corporations meet wage demands. Japan’s biggest union group Rengo will give its initial count on Friday, and it’s expected to secure a pay rise of above 4% - a thing that has not happened in three decades due to a sticky deflation in Japan. Any positive surprise on the wages front should boost the BoJ hawks and the speculation that the BoJ could hike rates as soon as next week. The USDJPY saw support below the 147 this week but the downside risks prevail. I believe that the BoJ will more likely to give a strong hint that it will hike rates than hike next week. But no one knows how the BoJ will hike rates. Would they rather surprise the market or prepare investors?  It’s been so long since the BoJ last hiked rates.

US crude rebounds

US crude tested the 200-DMA to the upside as the API data printed a 5.5-mio barrel fall in US oil inventories last week. OPEC raised its economic outlook for the year and said that oil demand will increase by 2.25mbpd this year and by 1.85mbpd next year. That was unchanged from their previous forecast. Still, oil bulls remained timid above the 200-DMA and the barrel of US crude is trading below this level this morning. A delay in Fed cuts could further reinforce offers above $80pb level.

(This story was corrected on March 13 at 15:27 GMT to say that Federal Reserve officials may sound cautious about the timing and the number of rate cuts this year, not rate hikes.)