PPI is now in the market purview

Markets

On Wednesday, U.S. stocks experienced a slight downturn as investors opted to cash in profits from shares of Nvidia and other chipmakers. Meanwhile, market participants are preparing for the release of Thursday's producer price data, which could provide additional insights into inflation trends and influence forward guidance at the upcoming Federal Reserve meeting. Last month's PPI release significantly reinforced the narrative of rising inflation and caused the market to wobble.

Meanwhile, the PPI data typically doesn't spark significant market movements. Still, given traders' ongoing concerns about pipeline inflation, another hotter-than-expected print could lead to minor turbulence.

Despite the unexpectedly high inflation figures released on Tuesday, US stocks and other correlated assets have not deviated significantly from their bullish trajectory, and even currency markets are slightly higher overnight. This cross-asset resilience indicates that Powell's relatively dovish testimony on Capitol Hill resonates heavily in market circles. His remarks have cemented expectations for rate cuts, making it challenging for traders to shift the needle back to a more hawkish setting, especially considering the unlikelihood of the Fed pivoting towards a hawkish stance in the near term.

Central banks are still constantly attuned to the inflation analogue, so the Federal Reserve is still cautious to prevent the rekindling of price pressures. However, interest rates remain relatively elevated for numerous businesses and consumers. This situation has a ripple effect, as homeowners are reluctant to relinquish their mortgages, constraining the supply of much-needed inventory in the housing market. This dynamic contributes to household inflation through various channels related to accommodation costs. Similarly, leveraged borrowers reliant on shorter-term, floating-rate debt face significant challenges in the corporate sphere.

The housing market situation is not a US-isolated problem but rather global, as an ongoing rise in housing values reflects a persistent imbalance between supply ( resale and new)

The current situation where the Fed funds rate is notably higher than the 10-year and 2-year Treasury yields is signalling a potential tightness in monetary policy, as indicated by the bond market. This inversion suggests that the Federal Reserve's stance is too restrictive, in the market's view. Consequently, companies that are less cash-rich and moderately leveraged are encountering challenges.

Indeed, there are compelling reasons for the Federal Reserve to consider rate cuts. However, the challenge lies in the inability to set different interest rates for various sectors of the economy. This limitation prevents them from providing targeted relief to sectors in need, such as debt and mortgage assistance for struggling industries, while simultaneously adjusting rates higher for other sectors like services.

Ultimately, the question is why the market has suddenly grown less wary of moderately hotter inflation than expected.

The sticky price index assigns much weight( some would say too much) to owners' make-believe equivalent rent, comprising over a third of the basket. Additionally, it heavily favours items that undergo price resets at the beginning of the year, such as insurance. This weighting means that annualizing the three-month change at the start of the year will likely result in a positive bias. Hence, these latest inflation reports are within the speculative trading desk’s tolerance bands on the presumption that the positive inflation skew turns negative as we progress through 2024. Hence, rate-cut probabilities remain on course.

Japan

The speculation surrounding an imminent rate hike by the Bank of Japan intensified further following an announcement by Toyota confirming its compliance with union demands for higher pay for the fourth consecutive year. This development fueled the ongoing discussion about the central bank's monetary policy direction.

For the markets, the stakes are reaching a critical juncture, akin to the impending moment of truth, which looms ever closer.

Japanese shares extended losses for the third consecutive day on Wednesday, marking the sixth decline in the last seven sessions. The Nikkei is currently trading around 4% below its recent highs.

The cessation of BoJ ETF-buying would likely accompany the end of negative rates and the formal abandonment of yield-curve control, which could be a real wallop to local stocks.

Even the short JGB widow maker trade is now fully subscribed.

Hence, it’s not a question of whether the BoJ won’t adjust the policy next week, at least in the market view; however, the question is guidance, particularly for the currency markets.

There is still a good chance to mitigate any potential market turbulence associated with existing negative rates and yield curve control; the BoJ could stress a gradual approach to policy normalization, which could then weaken the Yen ( after the rate hike knee-jerk) as traders shift back into yen-funded carry trades, where investors borrow yen at low-interest rates to invest in higher-yielding assets elsewhere. As a result, this could exert downward pressure on the yen as market participants seek higher returns in other currencies.

Oil market

Oil prices surged amid optimistic short-term outlooks from an industry think tank projecting a robust rebound in fuel consumption during the second quarter. Additionally, falling crude inventories in the United States contributed to the rally. The market was further fueled by escalating drone attacks on Russian refineries, leading some refiners to suspend operations and raising concerns about potential supply disruptions.