The Fed policy meeting on Wednesday is this week’s highlight

Markets

Friday’s US August CPI was probably the most anticipated one in years. The slightest deviation from consensus would settle the debate for this week’s Fed policy meeting from a market point of view. The result: headline inflation printed bang in line with expectations, accelerating at a monthly 0.4% rate to bring the yearly reading to 3.4%, the same as in July. Core CPI, however, quickened a tad faster than foreseen, from 0.2% to 0.3%. The annual number barely eased, to 2.45% from 2.5%. To quote Fed governor Waller from a speech early this month: “I judge that policy is currently only slightly restricting aggregate demand, and it may not take much acceleration in inflation to nudge me into supporting tighter policy.” So here we are: markets are now attaching an almost 90% probability to a Fed rate hike later this week with a follow-up move more or less priced in for December as well. The US curve bear steepened textbook style with net daily changes varying between +4 bps (2-yr) to -1.4 bps (30-yr). A drop in oil prices ($104/b from as high as $110) mainly supported the long end of the curve through easing inflation expectations. The 10-yr real yield instead crept higher towards a new 18-year high. The decline in energy prices outweighed the increased tightening bets for stock markets. Wall Street finished around 1% higher. Much of that is reversing at the start of the new week again. Saudi Arabia out of precaution after attacks closed its East-West pipeline, which acted as a key by-pass for the Hormuz Strait. Brent rises again towards $107 this morning. Stocks are under pressure, tech in particular following AI executives calling for restraint in model development to put the focus on safety first. Risk sentiment shielded EUR/USD somewhat from the widening interest rate differentials on Friday but the pair is now sliding at a faster pace. At 1.157 the pair is challenging this month’s lows.

The Fed policy meeting on Wednesday is this week’s highlight. Chair Warsh at the Jackson Hole Symposium said that "We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do." The August PPIs and CPIs put the disinflation narrative at least into question. Now it’s up to the central bank to put the money where its mouth is. Hiking to 3.75-4% not only makes economic sense, it would also help to put any concerns about political pressure to bed. Theoretically, the Fed and Warsh could kick the can down the road by saying the recent Treasury sell-off has already made financial conditions tighter even without a hike. But that could trigger a fire sale particularly at the long end of the curve. With the US 10-yr yield close to the psychologically important 5% barrier, which caused market tremors in the past, it’s a risk not worth taking. We don’t expect Warsh to offer much clues on what to expect beyond this week’s meeting. But assuming he still stands behind his Jackson Hole speech, implicitly or explicitly, front-end yields are well protected. The dollar in current circumstances has the best cards to play. From a technical point of view, nothing really changes unless it pierces through 1.15, though.

News and views

Swedish parliamentary elections are too close to call. The coalition around current PM Kristersson is trailing centre-left opposition around Social Democrat leader Andersson by 3 seats. The opposition is currently awarded 176 seats out of 349 available in Swedish parliament. However, the final result will only be available by Wednesday or Thursday according to the Swedish Election Authority. By then officials will count ballots that didn’t reach polling stations in time. At the previous elections in 2022, about 218k valid votes were still added to the preliminary result (+-18k difference between centre-left opposition and centre-right). Swedish expats for example tend to vote right so these votes can still alter the final result. The Swedish krone loses more ground this morning at EUR/SEK 11.26. Technical resistance stands at 11.33.

The University of Michigan’s consumer confidence indicator unexpectedly dropped from 51.7 to 47.8 in September. Year-ahead expectations for both personal finances and business conditions plunged. With a resurgence in fuel prices and trade tensions, consumers anticipate greater pressures on their pocketbooks to come. Overall, sentiment is now 16% below February, prior to the start of the Iran conflict, and 13% lower than a year ago. Year- ahead inflation expectations jumped from 4% in August to 4.6%, the highest since June. Long-run inflation expectations (5-10yr) ticked up to 3.4%, ending three consecutive months at 3.3%.

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