Market volatility has been low this week as investors digest the euphoria of recent record highs across global stock markets. But top tier is released on Thursday and Friday with US and European inflation reports potentially hugely impactful for markets. The current narrative has shifted in recent weeks towards the prospect of less rate cuts which start later in the year. A soft landing is now consensus, that is a scenario where the Fed has raised interest rates just enough to slow the economy and cool inflation, but without doing too much policy tightening to cause a recession. This week’s data will be critical in cementing this theme as some inflation remains sticky.
Fed’s preferred inflation measure
The US core PCE data lands on Thursday and is a focus for the FOMC, as it is a broader gauge of prices that dynamically adjusts to changes in the spending basket. It is seen picking up in January, to +0.4% m/m versus the prior. +0.2% and 2.9% y/y versus 2.8%. After both the CPI and PPI series surprised to the upside in January, expectations are for a solid report.
Indeed, a monthly print of 0.4% is much stronger than the 0.2% that economists believe is needed to bring inflation back to target over time. The flip side and softer data could mean prices are on track to hit the 2% inflation goal earlier than expected. Importantly, Fed officials have repeatedly said they will begin loosening policy before the PCE measure returns to target, so a weaker set of figures would hit the dollar and help the risk rally. Market pricing is now seeing just over three Fed rate cuts by year end and a 60% chance of a first move in June.
Euro area disinflation to continue
A further drop in eurozone inflation is forecast with the headline index of consumer prices in the 20 countries that share the euro set to fall to 2.5% from 2.8%, which will be closer to the ECB’s 2% target. The core rate, excluding volatile energy and food, is expected to decline to 3.0% from 3.3%. Lower energy and goods prices should help cool price pressures while service inflation could remain elevated around 4%.
As always, consensus for the region’s data will be shaped by regional releases with French, German and Spanish numbers all due on Thursday. We note that energy taxes are being reintroduced so we could see stronger than expected prints, especially in France.
But a softer report in the eurozone could generate more excitement about how soon rate cuts will start especially with the eurozone economy still struggling with stagnation. Markets are pricing near-enough a 25bp cut by the ECB at the June meeting with a total of 90bps of loosening seen by year-end. Consensus within the Governing Council appears to be to wait for the early 2024 wages data before easing policy and that will not be released until after the April meeting.
Market reaction
EUR/USD has been doing well recently with dollar softness and positive risk sentiment leading the major higher. Prices broke out of the descending bear channel after making highs above 1.11 late last year. The major is now trading around its 200-day simple moving average at 1.0827. The 50% point of the Q4 rally sits below at 1.0793 with resistance above at the next retracement Fib level at 1.0875.