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Market Wire:
Fed Likely to Stick to Easing Course Despite Strong Inflation, Labor Data

Matt Eidinger July 11, 2019

While the markets have been intently focused on the Fed this week, the US central bank has been fixated on inflation indicators.

Although the Personal Consumption Expenditures (PCE) index is its preferred measure, this morning’s CPI data from the Bureau of Labor Statistics (BLS) solidifies the chances of a 25-bps cut, as opposed to a 50-bps cut.

According to the data, headline CPI increased 0.1% during the month of June, beating market expectations for a flat reading. On a year-over-year basis, headline CPI grew at 1.6% – in line with economists’ forecasts.

Stripping out the volatile food and energy sectors, core CPI rose by 0.3% last month and 2.1% on an annualized basis – both more than expected.

The energy index declined a notable 2.3% during June, reflecting decreases in all energy sub-categories. The gains in the core CPI reading can be attributed to price increases in apparel (+1.1%) and used cars and trucks (+1.6%). Driven by increases in most rent categories, the shelter index rose 0.3%.

The food index was unchanged; gains in food away from home were offset by losses in food at home.

Although the US Federal Reserve prefers using personal consumption expenditures as a tool for measuring how close inflation is to its 2% target, today’s CPI data stands in stark contrast to the previous PCE release, which registered a 1.6% reading and has stoked concern the Fed increased rates too quickly in 2018 and will now have to take a step back.

At the Department of Labor (DOL), seasonally adjusted initial jobless claims fell to 209,000 during the week ending July 6. The four-week moving average fell to 219,250.

Yesterday, a dovish Federal Reserve chair coupled with an unexpectedly dovish Bank of Canada reversed some of the Canadian dollar’s recent gains, before markets calmed down and the spot rate returned to previous levels.

The trade-weighted dollar index moved down half a percent in the hours after the introductory text of Powell’s congressional testimony was released at 8:30 am yesterday.

This morning, activity in the spot market was muted, with the USD/CAD remaining untouched amidst the certainty US interest rates will move down 25 bps in three weeks.

According to overnight indexed swap data provided by the CME Group, the chances of a 25-bps cut stand at 78.6%. Immediately after this morning’s CPI release, the chances of a 50-bps cut fell from 30% to 21.4%.

Bottom Line: Today’s data on jobless claims signal a healthy US labor market. Similarly, the CPI data demonstrate inflation is near the Fed’s 2% target. However, because the PCE index is preferred by the Fed, it’s unlikely the Fed will be swayed from lowering interest rates as an insurance policy against future economic weakness.

Matthew Eidinger 
Fintech Specialist, Dealing Operations

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