Weekly Investment View: Could an Inflation Beat Spark a Rates Selloff?

This Week

• US Macro – Dominique thinks the June dot plot could show just one 2024 cut if this week’s CPI implies May core PCE above 35bp.
• US Rates – Antonio believes US rates could sell off this week if upside risks to CPI and retail sales materialise. The short end will drive this, but 10Y and 30Y yields should drift higher too.
• EM Macro – Caroline argues the BoI will not rush to cut rates given disinflation could prove temporary, inflation expectations are rising, and uncertainty over the war continues.
• EZ and UK Macro – Henry thinks key detail within UK labour market data supports the normalisation in services CPI, keeping a June BoE cut alive.
• Commodities – Viresh argues Brent at $81/ bbl would offer an attractive buying opportunity ahead of summer deficits – particularly via the options market.

Dominique Dwor-Frecaut – US Macro

The week’s most important data releases are CPI and retail sales. Sam’s CPI model expects a positive surprise in core CPI, while the Event Monitor reveals how to trade it.

This week’s April CPI (along with PPI) will likely drive the June FOMC dot plot. The May CPI, PPI and PCE come too late. They are due on 12, 13, and 28 June, so on or after the 12 June FOMC. The Fed focuses on PCE over CPI. They will therefore base the June FOMC on April PCE but build an advance estimate from this week’s CPI and PPI.

On current trends, core PCE is headed above the Fed’s Q4/Q4 forecast of 2.6%. In March, the 6m average was 25bp and the 3m average 36bp, against the 17bp/month or below needed to hit the Fed forecast (Chart 1). Therefore, the June dot plot will likely show at most two 2024 cuts, possibly only one if this week’s CPI imply May core PCE above 35bp, as that would suggest a YoY acceleration.

Antonio Del Favero – US Macro

If upside risks to CPI and retail sales materialise, US rates could sell off this week. The short end will drive this, but 10Y and 30Y yields should drift higher too. As Dominique mentions above, it will depend on the translation from CPI and PPIs into PCE, but our general view remains that inflation is stickier than the Fed wants.

If we are wrong and inflation is materially lower than consensus, and retail sales are weak, rates will rally and the market likely price between two and three cuts in 2024 (the SEP is currently at three).

Caroline Grady – Emerging Markets

Helpful base effects should put an end to the recent inflation acceleration in Israel. But with renewed currency weakness through March and April and a significant fiscal expansion (12m deficit running at 7% of GDP), disinflation could prove temporary. And alongside ongoing uncertainty over the war in Gaza and rising inflation expectations, the BoI will not rush to cut the policy rate further. A later start to Fed cuts will also matter, with the current -100bps policy rate differential the widest since late 2022.

Henry Occleston – Eurozone & UK Macro

This morning’s UK labour market data provided a mixed picture, with the detail key. Broad evidence still suggests slowing employment growth and a loosening labour market. The BoE will take comfort from this (Chart 5).

Rising wage growth could concern the BoE. However, the details are less hawkish. Business services and manufacturing led the beat, with consumer-facing services pay growth trailing (Chart 6). This is important as the BoE is concerned about signs of inflation persistence in the latter.

The data also likely reflected some employers pre-empting the minimum wage rise (in force April). The extent will be unclear until we have April data. Regardless, wage growth now appears highly likely to overshoot BoE expectations into the June meeting.

We still think the data will let the BoE cut in June. The BoE is focused on inflation and inflation persistence. The details of this print support normalisation in services CPI, but we must hear how speakers are reading into it. I expect a tick down in accommodation inflation at the April CPI print. Not getting that would greatly weaken the BoE’s ability to cut in June.

Viresh Kanabar – Commodities

Brent looks to be consolidating in a new $81-85/bbl range, while m2m3 time spreads are trading in a similar range around $0.5. Last week, three data points stood out:

• China crude imports fell slightly in April to 10.9mn b/d from 11.6mn b/d in March. However, combined with net product imports, China imported around 11.2mn b/d, unchanged from the previous month and in line with the average since the start of 2023. So while Chinese demand remains healthy, it is not yet firing on all cylinders.
• US crude inventories fell 1.4mn barrels, while gasoline and diesel saw builds of 0.9mn and 0.6mn. Overall, this report was mildly bullish crude relative to the five-year average as US crude exports picked up. However, product builds will put further pressure on cracks.
• Petroleum consumption in India rose 3.6% YoY (3mma) to 20.2mn tonnes, driven by continued strong acceleration in gasoline demand (9.9% YoY). Naphtha demand was also solid at 7.2% YoY, while diesel demand slowed to just 3.5% YoY.

This oil demand in India is up around 0.2mn b/d, in line with our forecasts. There could likely be a pickup over May given elections and subsidies to travel fuels, but we expect this to normalise over the next few months.

Speculative net-length continues to decline. It is now in the 20^th percentile (over the past three years), down from the 80^th percentile at the start of April. We think CTA selling drove last week’s price action.

We think anywhere around $81/ bbl likely offers an attractive buying opportunity ahead of summer deficits – particularly via the options market where implied volatility continues to fall towards 20%.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)