The unideal inflation dynamics explain why the Fed won’t be in a position to cut the rates soon

The FTSE 100 and the Stoxx 600 index closed at a fresh ATH on the back of rising dovish central bank expectations. The EURUSD bounced lower from the 50 and 200-DMA, while Cable tested its own 200-DMA to the upside on the back of strong GDP read last Friday, but the currency pairs need good news from the US inflation front to clear key resistances this week.

Released on Friday, the US Michigan sentiment and expectations numbers were a disaster. Not only the data showed that sentiment tanked in May, but the series of data also pointed at rising inflation expectations for the next year to 3.5%. That’s pretty much in line with where the US CPI has been stagnating since the end of last summer. Worse, the core CPI – which excludes useless stuff like food and energy that no one needs, is coming down slowly, but the index is sitting just a touch below the 4% level – that’s almost twice the Fed’s 2% inflation target. And the unideal inflation dynamics explain why the Federal Reserve (Fed) won’t be in a position to cut the rates soon.

So it’s in this tense and uncertain conditions that the US inflation data will land this week. A consensus of analyst estimates on Bloomberg survey points at a small improvement in both headline and core measures. If that’s the case, investors could breathe a sigh of relief and enjoy the dovish news from other central banks. We would then see the euro and sterling extend gains against the dollar, the yields ease and stock markets surf on a fresh wave of optimism. But if the numbers surprise to the upside for the 4th straight month, it will be hard to keep the Fed hawks contained. The dollar index kicks off the week a touch above the 105 level, the S&P500 is at a spitting distance from an ATH level, the US 2-year yield spiked to 4.87% on Friday, and activity on Fed funds futures gives around 60% chance for a September rate hike from the Fed. It will be interesting to see how the things will evolve from now to the end of the week. I am afraid there is a chance that we see another bad surprise given the surge in many regional Fed surveys.

Happily, the crude oil chart gives some hope regarding the energy inflation. The barrel of US crude fell 1.75% on Friday and slipped below the 100-DMA. The price of a barrel has been unable to make a move above the all-important $80pb level since it fell below this level at the start of May. Yet the geopolitical tensions remain high as Israel doesn’t listen to ceasefire calls from the US and the rest of the world. The US is in a tough position; it can’t really turn its back to its strongest ally, but the situation in Gaza and the rising protests against Biden’s ties with Israel give a very sour taste to Biden’s election campaign. So Biden – who is stuck between a rock and a hard place – vents his frustration on China; he is planning to double, triple or even quadruple levies on some Chinese goods.

China, on the other hand, continues to struggle with its own demons. Released during the weekend, the data showed that consumer inflation rose more than expected in April to 0.3% on a yearly basis, but producer price deflation continues with a 2.5% retreat in April. More disquietingly, the aggregate financing in China fell for the first time in history on the back of slower government bond issuance and a decline in shadow banking. The Chinese CSI 300 index is up by nearly 18% since the February dip. UBS and BNP upgraded their view on MSCI China recently, but the rally remains on a slippery path provided that the geopolitical challenges result in a deepening trade and technology war.

Elsewhere, the earnings calendar is busy with US big retailer earnings this week. The Chinese Alibaba will also report earnings, OpenAI is expected to announce some updates this Monday and Alphabet’s Google hosts its annual developer conference this week, which could bring plenty of AI news on the headlines.