Markets weigh inflation data and central bank signals as Fed, ECB policy decisions loom

Markets

Market focus shifted from the US labour market back to inflation. Mediocre labour data last week reinforced the case for the Fed to restart easing. Still, the market reaction remained guarded, especially on the pace of normalization. This caution prevailed in the wake of softer than expected August PPI data yesterday. Both headline and core (ex-food and energy) declined 0.1% M/M (2.6% and 2.8% Y/Y respectively). Core-core (also excluding trade) was more in line with expectations (0.3% M/M and 2.8% Y/Y). After the surprise rebound in yields after Tuesday’s downward BLS payrolls revision, US yields yesterday eased 1.5 bps (2-y) to 4.2 bps (10-y). Even so, three 25 bps steps by the end of the year are still not fully discounted. Markets apparently first want more additional Fed guidance on the balance between labour and inflation. The outperformance at the long end was reinforced by a strong 10-yr Note auction later in the session. EMU interest rate markets treaded water ahead of today’s ECB meeting. A brief USD-dip after the PPI-release was soon reversed. DXY (97.78) and EUR/USD (1.1695) showed no directional bias at all. The Nasdaq and the S&P 500 closed at (minor) new record levels.

Three topics are bound to capture markets’ attention today. The ECB holds a regular policy meeting, with the assessment supported by new staff economic projections. In the US, August CPI data are providing the final key input ahead of next week’s Fed policy decision. The US Treasury sells $22bn of 30-y Bonds. More than is the case for the Fed, the ECB can tell markets that it is in a good place. Headline Inflation is perfectly on target (2.1%). Core is still slightly higher (2.3%), but in June the ECB projected inflation to ease next year, before returning to target in 2027. There is little reason to change this view. Growth recently held up better than expected. The ebbing of trade tensions and fiscal stimulation filtering through might cause a slight upward revision in growth forecasts. ECB Chair Lagarde has every reason to maintain the July strategy of keeping communication deliberately uninformative about future interest rate decisions. With markets still not completely excluding a final rate cut (65% chance) next year, the downside in short term EMU yields looks well protected. US August CPI is expected at 0.3% M/M for both core and headline to result in 2.9% Y/Y (from 2.7%) and 3.1% (unchanged) respectively. Recent price action suggests that sub-consensus CPI is needed for markets to fully embrace the idea of the Fed (re)accelerating policy easing. In case of mixed, in line CPI data, the 3.5% support (2-y) can survive for some time. The 30-y US Treasury action also deserves a closer look. High absolute yield levels and the fiscal sustainability theme moving a bit to the background, triggered renewed buying interest. Interesting to see how much easing in (fiscal) risk premia investors are prepared to accept. On FX markets, the ECB-US CPI combo probably extends the recent directionless USD (& EUR/USD) trading.

News and views

Mexico is planning to impose tariffs of as much as 50%, applicable to more than 1400 product categories including cars, steel, toys and furniture, coming from countries that have no trade agreement with Mexico. Among the biggest to be hit are South Korea, India and China. Mexico has for example become the biggest destination for Chinese cars. Its economy minister said the decision is to protect jobs but it’s also considered a move to appease the US administration ahead of a review of the USMCA (US-Mexico-Canada) trade agreement next year. Both Canada and the US took measures in recent years to prevent Chinese vehicles from entering their markets.

The RICS’s UK house price tracker defied expectations for a slight improvement in August, dropping instead to the lowest level since January 2024. The index retreated from -13.4% to -18.5% with further price declines expected in the next three months. The surveyors said that sales are falling at an accelerated pace and buyer demand is weakening in most of the UK. Head of market research and analysis at RICS Parsons said that “Concerns over the wider economic and fiscal outlook, combined with questions around the future path of interest rates amid stubbornly high inflation, are weighing on sentiment at this time.”

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