Fed Holds Fire Amid Rising Inflation Risks: Markets Turn Data-Dependent

Powell was careful not to use the word “stagflation”, but it is essentially what they are thinking and the most probable risk developing in the system - but until such time that they see it manifest in the data, then Powell & Co will be paid to do very little.

In effect, Donald Trump is not just the President of the US, but he is the quasi-Chair of the Fed, and to an extent CEO of most of corporate America. His ability to control the narrative and the headlines on trade talks keeps corporate decision makers and many markets participants firmly glued to each and every headline, so until we have a firm consensus on where tariff rates settle very little is going to be decided on to manage the fallout.

US corporations have expressed their concerns on demand, supply and expected prices paid in the soft data survey’s but are yet to act on these concerns – firms are not going to lay off workers until they have the ingrained clarity on whether this could prove to truly be a supply or a demand shock. We may get some guidance when the US retailers report numbers in the next two weeks and how they anticipating and planning to manage prices, but in effect, we are in a fairly drawn out process of hard-economic data watching – with weekly jobless claims, nonfarm payrolls, durable goods, JOLTS job openings/layoffs, retail sales all getting increased focus resulting in likely heightened markets sensitivity to the outcome, as they will to the incoming CPI and PPI inflation reports.

The lack of move on the day for the US 2yr Treasury with yields unchanged at 3.77% speaks to the wait and see stance held by Powell & Co – with US swaps now implying a 22% chance of a cut at the June FOMC meeting, an 87% implied cut held for the July meeting, while we see three 25bp cuts priced by year-end. This pricing is obviously a moving target and if any on of the key hard data releases comes in markedly soft and/if the shipping data and the number of vessels sailing to the US was to turn far lower, then the prospect of a June cut will increase and potentially become a ‘live’ meeting in the market’s eyes.

Of course, seemingly unlike the Fed’s thinking, we need to consider a world where the data doesn’t crack and deteriorate and US businesses and consumers remain resilient – that may take an accelerated timeline on US-China talks and for actual substance to emerge – but it is a scenario to consider and plan for - and with US forward inflation swaps currently pricing US inflation to rise to 3.63% over the coming 12-months that would put the Fed in a real predicament.

This dynamic means having an open mind to the data trends, and the market's anticipation of growth and inflation, as well to what corporates are saying. For now, the idea of holding pat and waiting sees the USD index testing the top end of its recent 100-98 range, with the USD working well on the day against all G10 FX, with notably USD upside vs the AUD, NZD and JPY. Gold longs have been cut, and US equity finds a renewed bid, largely helped by a solid close in Nvidia with headlines coming in late in the day that Trump is rescinding export controls on chips.

We look ahead to more sanguine open across the Asian equity bourses, with some underperformance expected in Hong Kong, while the NKY225 should open 0.4% higher. The ASX200 should unwind largely unchanged, although ANZ’s 1H25 earnings could move the dial, and on first blush, we see cash earnings beating expectations, with NIM and the interim div inline. GBP traders will look to the BoE meeting and the certainty of a 25bp cut – the move in the GBP and gilts coming from the guidance and the appetite to ease in the June meeting, a factor that is implied at a 55% probability.

Good luck to all.