A softening in US consumer and producer prices significantly outweighed the Fed's policy meeting for market impact this week, driving a rebuilding of rate-cut pricing. Near enough to two rate cuts from the Fed are now discounted by year-end, despite the FOMC's updated projection being lowered from 3 cuts to 1 cut for 2024. In other central bank-related news, the Bank of Japan left rates unchanged as a continued lack of clarity around plans to dial back on bond purchases weighed on the yen. The fallout from last weekend's EU elections continues to reverberate across markets, with France at the centre of the moves following President Macron's call for a snap election. French spreads over German Bunds widened sharply; the CAC40 index fell more than 6% on the week; and the euro lost ground to the US dollar.
Early estimates suggest the Fed's preferred core PCE deflator is on track to print at 0.2% for the second month in succession - a run rate close to what is required to be consistent with the 2% target for annual inflation in the US - after May's data on consumer and producer prices was below expectations. However, with the data coming in either side of the Fed's policy meeting, the FOMC struck a cautious tone. Headline CPI printed at 0%m/m (vs 0.1%) seeing the annual pace slow from 3.4% to 3.3%, while the core rate was 0.2%m/m (vs 0.3%) and 3.4%yr from 3.6% previously. This was subsequently backed up by a 0.2% decline in producer prices in May (2.2%yr) as energy prices fell. Broadly, these readings indicated that the disinflationary process was starting to regain some of the momentum it lost through the early part of the year. Notably, markets were encouraged by services prices (0.2%m/m/5.2%yr) posting their slowest month-on-month rise since September 2021, a sign that pressure may be abating in some of the components where inflation has been more persistent.
The FOMC once more left rates on hold in the 5.25-5.5% range; however, the focus centred largely on the updated Summary of Economic Projections and Chair Powell's press conference. In effect, the FOMC was relatively more hawkish than it was at the previous forecast round in March, but markets have given very little weight to that interpretation given this week's inflation data. This is mainly because the FOMC raised its inflation outlook to 2.6% for the core PCE deflator this year (from 2.4%) and to 2.3% in 2025 (from 2.2%). In response, the projection for 3 rate cuts in 2024 held in March was lowered to a single 25bps cut; but 100bps of easing was then projected for next year compared to 75bps previously. Chair Powell said that the lack of progress in lowering inflation earlier in the year meant that the thinking was the easing cycle would be delayed until the data provides the FOMC with greater confidence that inflation is headed back to target. However, he indicated that more inflation data along the lines of the May report - not fully factored into the June projections - could change assessments.
Attention in the UK turns to next week's Bank of England Policy meeting. Markets effectively priced out any chance of a rate cut following the April inflation report (released in late May) that showed a stronger-than-expected rise in services prices (5.9%yr). That pricing wasn't swayed by elements of softness in this week's labour market data, including a sharp increase in jobless claims to their highest level since 2021 and an uptick in the unemployment rate from 4.3% to 4.4%. Although the MPC is expected to hold the key policy rate unchanged (5.25%), it could potentially adjust its guidance for rates needing to remain restrictive for 'an extended period', presaging a cut in August.
Australian labour market data looks unlikely to shift the dial going into next week's RBA meeting. The Board is set to leave the cash rate unchanged (4.35%) while retaining the guidance that it is 'not ruling anything in or out'. Employment advanced by a net 39.7k in May, making it back-to-back above consensus outcomes following the 37.4k gain in April. With the participation rate holding at an unchanged 66.8%, the strength of the employment figure drove the unemployment rate down from 4.1% to 4%. As I discuss in my full review of the report (see here), the labour market remains robust but conditions have eased from the peak levels of tightness around late 2022 to early 2023.
