Paring Back From Extremes

WHERE WE STAND – There’s nothing like a good old fashioned bit of over-extrapolation to provide some mid-week market excitement.

That certainly seemed to be the case yesterday. One cooler-than-expected UK CPI print, and in the market’s eyes all is rosy once more here in Blighty. One cooler-than-expected US core CPI print, and all is dovish once more in terms of the Fed outlook, at least from Mr Market’s perspective.

In sum, then, the day was one where we saw markets pare back from extremes – the peak fiscal fear extreme here in the UK, and the peak hawkish policy worry in the US. Now we’re back in what feels like a more neutral stance, focus will likely quickly turn to next week’s presidential inauguration, and President-elect Trump’s initial policy plans. Amid reports of up to 100 executive orders being signed on Day 1, long black sharpies – The Donald’s pen of choice – could be a prudent position (not advice!).

Digging into those market drivers a little more, headline US inflation rose 2.9% YoY in December, in line with market expectations and the fastest such rate since July. However, core prices, which exclude the volatile food and energy components, rose by 3.2% YoY, 0.1pp below consensus expectations, and the slowest pace since last August, a sign that underlying inflationary pressures are beginning to fade, slowly but surely.

Clearly, core CPI running 1.2pp north of the Fed’s target isn’t exactly cause for celebration, with the figures highly unlikely to move the needle in terms of the FOMC’s policy outlook – a January ‘skip’ remains the base case, with the question of whether that becomes a prolonged pause depending on how data evolves during the first quarter.

Market participants, though, will never wait for the data, and instead will always jump to conclusions.

That’s exactly what we saw yesterday – stocks tearing higher, led by small caps; the dollar rolling over, as the DXY dipped back under the 109 handle; and, Treasuries rallying across the curve, led by the belly, with benchmark yields in the 5-10 year segment falling as much as 15bp on the day. The USD OIS curve also repriced in a dovish direction, now fully discounting the first 25bp cut by July, from September previously, while also discounting a total of 41bp of cuts this year, 9bp higher than pre-CPI.

I’d argue that the majority of these moves were an unwind of extreme hawkish positioning, as opposed to fresh cash entering the market. Overall, the data does little to materially alter the macro narrative, that the US economy is continuing along a relatively bumpy disinflationary path back towards the 2% target over the medium-term. Conviction, also, likely remains lacking, amid uncertainty over the fiscal outlook from next week onwards.

Speaking of which, while the fiscal outlook remains dire here in the UK, the luckiest lady in markets yesterday was probably Chancellor Rachel Reeves. Those cool-ish US inflation figures, combined with cooler-than-expected UK CPI data, saw Gilts gain ground across the curve, with 10-year yields notching their biggest one-day decline since 2023, falling almost 20bp.

That UK inflation data, incidentally, pointed to CPI having risen 2.5% YoY last month, 0.1pp below market expectations, while core prices rose 3.2% YoY, the slowest pace since September, and services CPI rose 4.4% YoY, the lowest rate since March 2022, and considerably below the BoE’s 4.7% forecast.

As with the US inflation figures, data of that ilk isn’t exactly cause for celebration, with underlying price pressures still elevated, though participants and policymakers alike breathed a huge sigh of relief that the data wasn’t hotter than had been feared, and thus cemented expectations that the BoE will deliver a 25bp cut at this year’s first meeting on 1^st February.

Nevertheless, almost all of the fall in inflation came as a result of airfares not repeating the strong jump seen in 2023, and by virtue of the ONS’s survey referencing prices as of 10^th December, prior to the bulk of pre-Christmas price rises taking effect across the economy.

Furthermore, while peak fiscal worries may have passed, and Chancellor Reeves has lived to fight another day in the job, the UK economy remains far from out of the woods. Fundamentally, inflation remains elevated, growth stagnant, and with Gilt yields elevated, the fiscal rules remain in peril. Any UK bulls emerging should probably put the corks back in their champagne bottles, as I still see little reason to like GBP assets.

LOOK AHEAD – Another busy docket awaits today.

UK data once again kicks things off this morning, with November’s GDP data due. The figures are set to point to the economy having grown by 0.2% MoM, snapping a 2-month long run of consecutive contractions. Still, the figures are highly unlikely to materially alter the BoE outlook, or the stagflation narrative with which the UK must grapple.

Meanwhile, the US economic calendar also features plenty of notable releases. December’s retail sales print is the most significant, given the pivotal nature of consumer spending in underpinning the continued economic expansion. Headline sales are seen rising 0.6% MoM over the festive period, building on the solid 0.7% MoM gain seen in November. Also due today include the weekly jobless claims report, as well as manufacturing figures from the Philly Fed.

Lastly, bank earnings continue before the open, with Bank of America and Morgan Stanley both set to report, after solid prints from peers such as Goldman and JPMorgan yesterday.