Last week, markets celebrated signs that inflation in the US is slowing faster than previously expected. Equities, bonds, and commodities all pushed higher, while the dollar weakened.
However, there are still some tail risks that could derail the disinflationary trend. One risk is that the recent bounce in the US housing sector could lead to higher home prices and rents, which would put upward pressure on inflation. Another risk is that commodity prices could continue to rise, which would also push up inflation.
In terms of central bank policy, the Bank of Canada and the Reserve Bank of New Zealand both kept their policy rates unchanged last week. However, the incoming CPI data from these two countries could provide some short-term trading opportunities.
The other major focus for markets this week will be the UK CPI data. Markets are expecting headline CPI to slow to 8.2% from 8.7%, but core CPI is expected to remain unchanged at 7.1%.
There is some possible asymmetry to the pound’s reaction to the UK CPI release. A big miss in the data could see a big repricing in interest rate expectations, putting pressure on the pound.
However, a big beat in the data could see some initial upside for the pound, as it pushes rate expectations higher. However, we would not be surprised to see markets fading that initial strength, as the impact of higher inflation would be negative for the UK economy.
Finally, the US retail sales data will be released later this week. The dollar saw a ton of depreciation last week, as US inflation showed further disinflation.
Nonetheless, Friday’s lack of upside in the dollar despite a very big jump in consumer sentiment data and upside in consumer inflation expectations was a surprise.
Given that limited reaction, there is a question mark on how strong the dollar could react this week if retail sales data surprises to the upside. However, considering the amount of depreciation we’ve seen in a very short space of time, chasing the dollar lower doesn’t seem attractive either.
With the markets currently pricing in about 140bps of rate cuts from the Fed by the end of next year, the risks for markets is that pricing has gone too far towards rate cuts. This means that an upside surprise in retail sales arguably offers the clearer edge to trade.
Overall, markets are celebrating the recent disinflationary trend, but there are still some tail risks that could derail this trend.
Investors should be aware of these risks and be prepared to adjust their portfolios accordingly.
This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorised to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
All trading carries risk.
