US Inflation Data Could Disrupt Dovish Fed Trades

Flight to safety continued on Wednesday, as Middle East tensions rose by another notch after Iran-backed Hezbollah said it fired missiles at an Israeli military post near the Lebanese border. US Treasuries, gold and Swiss franc gained.

Gold extended gains to almost $1880 this morning, as the US 10-year yield fell to 4.55%. The dollar-franc fell below its 200-DMA and is preparing to flirt with the 90-cent mark, as the dollar index lost ground for the 6th straight session. Crude oil, however, fell more than 3% after the API reported a huge – more than 12-mio barrel build – in US crude inventories last week. The latter came as a relief to those worried about supply disruptions due to rising Middle East tensions. 

The easing US yields and the dollar’s depreciation are of course due to mounting tensions in the Middle East, but they are also due to a recent softening in Federal Reserve (Fed) speakers’ policy approach. We spent the week hearing that the Fed may have done hiking the interest rates and that the recent surge in the US long-term yields should give room to the Fed to sit down and evaluate.

Released yesterday, the minutes from the latest FOMC meeting suggested a less hawkish tone from the US policymakers. The Fed members agreed last month that the rates should remain high for long, but they also noted that ‘the risks of overtightening had to be balanced’ against bringing inflation toward the 2% policy target.  

h2 Equities Extend Rebound /h2

The probability of a no rate hike in November jumped above 90% after the Fed minutes, whereas this probability stood at around the 70% level at the beginning of this week. US fed funds futures price in more than 70% for a no hike in December as well, whereas this probability was closer to 50/50 a few days ago.  

The retreat in US Treasuries and the dollar is not purely driven by, yes, a swift move to safe-haven assets. It is also driven by the Fed’s expectations. This is certainly why we also see the S&P 500 extend gains for the 4th consecutive session. The S&P 500 gained every day since tensions in the Middle East started. If the yields were down only on the Middle East war, risk assets – like equities would have been left behind. This is not the case. Investors buy stocks, they buy bonds, and they also buy some gold and Swiss francs to hedge it off.  

h2 But Inflation Could Spoil Sentiment /h2

Revealed yesterday, the producer price inflation in the US came in higher than expected. The headline PPI jumped from 2% to 2.2%, whereas the market expectation fell to 1.6% in September. The uptick was due to rising energy prices since summer and the strongest rise in food prices in nearly a year. Core PPI on the other hand rose from 2.5% to 2.7%, leaving the expectation of a fall to 2.3% well behind.

Due today, the US CPI data could, or could not show a further fall in headline and core inflation. A higher-than-expected set of inflation data could scale back a part of the recent dovishness regarding the Fed and reverse a part of the recent gains in US Treasuries.  

Written By:
Ipek Ozkardeskaya