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Weak Inflation Raises Odds on October Fed Cut

Karl Schamotta October 10, 2019

American consumer prices flatlined in September and underlying inflation pressures subsided – strengthening calls for another rate cut at the Federal Reserve’s October meeting. Numbers released by the Bureau of Labor Statistics this morning show that headline inflation was unchanged last month, up 1.7% over a year earlier as price momentum weakened to a post-January low. Markets had expected gains to top 0.1% month-over-month and 1.8% year-over-year.

Excluding volatile food and energy costs, so-called core inflation climbed 0.1%, also missing expectations in rising 2.4% over the last year.

Separately, initial claims for unemployment benefits fell to 210,000 in the week ending October 5, down 10,000 from the week prior. The four-week moving average rose to 213,750, an increase of 1,000 from the previous week’s revised number.

Minutes from the Fed’s September meeting showed that officials are unanimously concerned about rising uncertainty levels but are more divided on the appropriate monetary policy setting – with some debating when to end the current sequence of rate cuts. Labor markets remain strong, but – particularly coming after yesterday’s sharp drop in producer prices – today’s data should help swing the balance slightly toward the doves, providing more evidence of a deceleration in the American economy.

A record of the European Central Bank’s September meeting released this morning also illustrated rising dissent among policymakers. “A very large majority” agreed with cutting the benchmark deposit rate to -0.5%, but several members were against launching an open-ended quantitative easing programme.

“A number of reservations were expressed about individual elements of the proposed policy package,” and some said that continued bond purchases “would exhaust the purchasable universe and call into question the program limits”. This echoed a report in the Financial Times this morning, suggesting that the bank’s monetary policy committee – an arms-length advisory body – had argued against a resumption of bond purchases at the time.

In an indication that officials are worried about the financial market tail wagging the central bank dog, “It was also cautioned that the Governing Council shouldn’t try to accommodate market expectations but should base its decisions on its own assessment…An argument was put forward that in an environment of high uncertainty, to exceed market expectations might be counterproductive, as this might be viewed as signaling a worse outlook than embraced in the forecasts.”

With hawkish tendencies coming to the fore ahead of Christine Lagarde’s turn at the helm, the euro has broken back through a key psychological resistance threshold this morning and is trading at levels last seen in mid-September.

As conflicting narratives swirl around today’s US-China trade talks, risk-sensitive currencies like the yuan, Canadian dollar, and Australian dollar are experiencing turbulence. The three weakened yesterday after a Chinese official appeared to rule out a comprehensive agreement, saying that a “partial” trade deal that involved purchases of American agricultural commodities might be possible in the near term. Those losses were reversed last night after Bloomberg reported that the two sides had formed an agreement on exchange rates, which – although rendered meaningless by the fact that China hasn’t been engaged in manipulating its currency downward for several years – might clear the way for a suspension of next week’s planned tariff increases.

Against an increasingly volatile political backdrop in the United States, a symbolic trade deal in the next month does seem possible – but with deeper structural issues and all-important strategic imperatives underlying the relationship between the two powers, a more meaningful reset looks unlikely, to say the least. And with Donald “Lucy” Trump holding the football, today’s over-optimistic markets look a lot like Charlie Brown trying to kick off…

Karl Schamotta
Chief Market Strategist

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