The Daily Update - US inflation

The ‘eagerly’ awaited US inflation and retail sales data came out earlier today. An upside shock in these could have further uneased the both bond and equity markets, still teetering in the ‘fear zone’ with the VIX remaining above the 20 level. Whilst a tempered or only slightly stronger-than-expected reading would be enough to convince markets that the Federal Reserve would move ahead with tightening monetary policy at a faster pace than 2017, but without encouraging an inflation scare. US Treasuries ahead of the data release held steady with the 10-years trading around yields of 2.82% and the 30-years around 3.11% both ~7bp off their recent highs.

In fact, inflation came in above expectations, with January’s Core CPI up 1.8% YoY versus forecasts of 1.7% and in-line with December’s reading. But there was a surprising disappointment in retail sales, which fell -0.3% in January when a gain of 0.2% was expected, along with December’s sales figure also being revised down to flat from the earlier estimate of 0.4%. The initial result of these was a modest rise in Treasury yields with the 30-years 3bp higher, yielding 3.14%, and market forecasts for a March rate rise moving from 93% to 100%. Probabilities for subsequent rate hikes also rose a little with a 91% probability of at least one further rate hike this year (versus 86% prior to today’s data).

It seems the near-term path for the Fed funds rates is almost inevitable with Federal Reserve Chairman Jerome Powell stating, in his first public comments in the new role as he was sworn-in on Tuesday, “We are in the process of gradually normalizing both interest rate policy and our balance sheet” with the dependable caveat that the Fed “will remain alert to any developing risks to financial stability.” Any hype around CPI at 2.1% being above the 2% target isn’t convincing or worrying as the Fed has always been clear that it sees the less volatile Core PCE inflation as the better measure with the latest reading (for December) at 1.5%, below target. Continuing to follow market reactions and Fed comments is key until the next PCE release on the 1st of March.

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