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All Eyes on US Inflation

The week started on a positive note on this side of the Atlantic Ocean, and on a mixed note on the American side. Equities in Europe were better bid on Monday, fueled by luxury stocks like LVMH for example which added 14 points to the index after Hermes hit a record high last week on string quarterly results. The Dutch Adyen extended last week’s post-earnings gains, adding around 34 points to the Stoxx, while Arm holdings jumped another 30% on Monday, after jumping more than 50% in the immediate aftermath of releasing its own quarterly results. All this to tell you that the rally in the European and US stock markets are somehow shouldered by a robust market reaction to encouraging corporate results. But a part of it is supported by the rate outlook. And the rate outlook is coming on slippery ground with every Federal Reserve (Fed) official adding his or her pinch of hawkishness into the mix. Yesterday, Fed’s Michelle Bowman said that the rates are in a good place to keep pressure on inflation and that there is no need to ease rates soon. Likewise, Richmond Fed’s Thomas Barkin said that they are ‘closing in on inflation’ but that they ‘are not there just yet’.

This being said, the New York Fed’s latest inflation survey came with a good surprise. The one and five-year expectations remained unchanged from the month before, but the 3-year inflation expectations fell to the lowest level on record, to 2.35%. That’s what the Fed is working so hard to achieve. And inflation expectations are very important to keep the actual inflation numbers in control. Therefore, the encouraging inflation expectations give hope that the Fed would start cutting rates despite strong growth and spending. However, the expectation of five rate cuts from the Fed is no longer the base case scenario; investors now see four rate cuts being more likely, with the first rate cut priced in at nearly 50-50 for May, and almost fully for June.

These probabilities could change today, in one way or the other, with the latest inflation update. Headline inflation in the US is expected to fall below 3% in January, and core inflation is seen easing to 3.7%. A softer-than-expected set of data will likely boost the May rate cut expectation, keep the dollar index below the 100-DMA and support equities. An unwanted upward surprise, however, should further hammer the May cut expectations and shift focus to June. In this case, we could see the US dollar index finally drill through the thick 100-DMA offers, and some profit-taking in the S&P500.

Crude eyes 200-DMA

American crude consolidates gains above $77pb and is preparing to test the 200-DMA to the upside. Trend and momentum indicators are supportive of a move above this level. Aramco says it sees robust global oil demand this year, OPEC and IEA will release their own predictions today and Thursday respectively. Of course, the predictions from OPEC should be expected to be rosier than the reality – because they have all the interest in the world to fuel oil prices – but the strong US growth and decent Chinese stimulus are indeed positive for the supply-demand dynamics.

However, note that rising oil prices are a double-edged sword. Good growth is positive for oil prices, but higher oil prices are not good for easing inflation. Hence, any U-turn in inflation would get the major central banks to further tighten their purses’ strings, hit growth prospects and hammer a potential oil rally. In conclusion, a rally above the $80pb could be hard to sustain – if the Chinese stimulus story fails to gain traction.

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