Sweet and Sour

US headline inflation fell to 3.1% as expected, thanks to an almost 9% fall in gasoline prices since last year, although shelter inflation – which is where everyone sees the biggest potential for easing – remained sticky yet another month. Core inflation eased to 4% on a yearly basis, BUT headline inflation was slightly higher-than-expected on a monthly basis. And that small uptick has raised suspicions that the Federal Reserve’s (Fed) final stretch in combating inflation may be more challenging than anticipated.

The latter triggered a mini selloff in the 2-year bond right after the data, yet the selloff didn’t last long. The US 2-year yield is about where it was yesterday morning. Crude oil fell to $68pb even though the US oil inventories fell 2.3 mio barrels according to the API.

With the latest inflation report behind us with minimal fanfare, the Fed officials will lightheartedly keep interest rates steady this month. Economic forecasts and the dot plot will play a crucial role in providing insight into the perspectives of Federal Reserve officials regarding expectations for rate cuts.

According to activity on Fed funds futures, the Fed should gently start cutting the rates by May; that possibility is given around 75% probability, slightly less than 80% before yesterday’s CPI print, while the probability of a March hike fell to around 44% from nearly 50% on that mini spike in monthly headline inflation. In summary, rate cut bets are being placed for a rate cut in March or May 2024. May the best win.

Today, we will probably face a satisfied, calm but cautious Powell, who will say that the Fed has done a great job fighting inflation, but that the rates will remain restrictive as long as needed. One dovish tweak could be deleting ‘additional policy firming’ from the post-meeting communication.

In the best-case scenario, the doves will make a mountain out of the smallest dovish details that could justify a further fall in yields. The US dollar will likely remain under pressure below the 104.30 level, the major 38.2% Fibonacci resistance that should keep the US dollar index in the bearish consolidation zone. We could see the US 10-year retreat and even – shortly – test the 4% mark to the downside, and the 2-year yield – which captures the Fed expectations – to remain between 4.50/4.70 zone. Lower than that becomes unreasonably overstretched.

In a more down-to-earth scenario, Powell will contain market optimism and rectify the rate cut bets. If so, we should see correction and consolidation in bond and stock valuations during the final weeks of the year.