Cost of Prematurely Crying Victory

Fundamental analysis of Forex market

Ouch! The US inflation data release didn’t go according to the plan yesterday. The headline figure printed 8.3% inflation in August, higher than the 8.1% expected by analysts, and happily, slightly lower than last month’s 8.5%.

Yet, the US food price inflation accelerated to 11.4%, from 10.9% printed a month earlier due to high energy prices, the war in Ukraine – which disrupted the wheat supply, a drought in Brazil that put a severe upside pressure on coffee costs and a bird flu outbreak in January that pushed chicken and egg prices higher.

Plus, the core inflation, which doesn’t take into account the volatile food and energy prices accelerated faster than expected to 6.3%, whereas the expectation was a slight rise from 5.9% to 6.1%.

To say the least about the most, the latest US CPI data hasn’t been as soft as investors hoped it to be, nor has it been as optimistic as investors priced it to be. The 10% fall in energy prices was compensated by higher rents, medical care and food prices. All items excluding energy rose 7.4% in the past three months. That was faster than the figures printed last spring.

It’s needless to say that the hope of seeing a dovish pivot regarding the Federal Reserve (Fed) policy is clearly dashed. Activity in Fed funds futures price in a 100% chance for at least a 75bp rate hike at the FOMC’s meeting next week, while there is 34% chance of a 100bp hike next week.

Bets that the Fed’s target rate will go above 4% by the end of this year spiked to 80% from 25% before the CPI data yesterday. The US benchmark rate is seen at around 4.3% in early 2023.

And the chatter of a possible rail strike in the US – which would send another supply chain shock throughout the economy – is a fresh factor that could prevent inflation from falling this month, and adds to the hawkish Fed expectations.

Market reaction to the cocktail of bad news and data was wild yesterday

The US 2-year yield spiked more than 5% to 3.80%, the US dollar index jumped 1.50%, and equities slumped. The S&P500 futures fell free as soon as we saw the inflation print come in, and the index closed the session 4.30% lower, having slipped below the 4000 mark.

Two major catalyzers of the two bullish price actions since summer have now both fallen.

  • The summer rally was due to the softening Fed expectations due to recession chatter. Jerome Powell killed that hope at his Jackson Hole speech, saying that the Fed will tighten to fight inflation despite damages to the economy. That was the first hit.
  • Then, the markets got back on feet on hope that inflation may have slowed enough to allow the Fed to soften its tone later this year. And yesterday’s inflation data shot that hope to the ground, as well.

In summary, both the recession, and the softer inflation catalyzers are both gone now. What that means for the market is: the S&P500 could continue its journey to the south, and we could see the index fall to 3800 mark in the coming weeks.

Oil down, then up

The strong inflation data, which boosted the Fed hawks, also weighed on the global growth prospects sending the barrel of American crude down to $81 first. But oil managed to recover losses on news that the US would refill the Strategic Oil Reserves at prices below $80 per barrel. The latter gave a boost to the bulls and pushed the price of a barrel to $88 mark. We are around $87 this morning, with however, topside seen capped into the $90 psychological resistance.

Every news is bad news for gold

Gold tipped a toe below the $1700 level posterior to the US inflation data and is trying to find ground around this level this morning.

Prospects for gold are soft for both the hawkish and dovish Fed expectations. The hawkish Fed expectations boost the dollar and the US yields and weigh on gold appetite. Dovish Fed expectations, on the other hand, boost the risk appetite, and drive capital to riskier, and better yielding assets – like equities, leaving gold behind. So, the risks in gold remain tilted to the downside, and a further fall toward $1650 is on the cards.

Due today: More inflation data

The UK just revealed its latest inflation figure this morning. Inflation in Britain came in 9.9% in August, below the 10% mark, and below 10.2% expected by analysts. How great!

The softer than expected figure didn’t do any good to the pound, however. Cable, which was doing just fine above 1.17 before the US inflation data punched the pair to the ground yesterday, slipped below 1.15 after the CPI release.

Across the Channel, the strong dollar abated the EURUSD bulls and pushed the pair below parity, yet again. News that Ukraine is pushing back the Russian troops are positive for the euro, but there is little chance that the optimistic war news would take the upper hand, when the dollar is so strong at the wake of such a disappointing US inflation data.

Later today, the US will reveal the latest producer price index. The PPI is expected to have eased from 9.8% to 8.8% in August. A sufficiently soft figure could spray some water on fire, but will hardly reverse the bad mood. The dollar will likely remain strong, equities, gold and cryptocurrencies will likely remain under pressure until investors find another glimpse of hope, somewhere in the dark.

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