Lower-Than-Expected PPI Fuels Expectations for Fed Rate Cuts as CPI Awaits
According to the report released yesterday by the U.S. Bureau of Labor Statistics, producer prices in the U.S. rose less than expected in July. The headline Producer Price Index (PPI) increased by 0.1% month-over-month, below the 0.2% expected increase. On an annual basis, PPI rose by 2.2% following the previous 2.7% increase, missing the market expectation of 2.3%.
The July increase in producer prices primarily reflected a rise in goods costs, which climbed by 0.6%, marking the highest growth since the 1.1% rise in February. Rising energy costs drove sixty per cent of this increase.
In contrast, service costs fell by 0.2%, marking the largest decline since March 2023. A 1.3% drop in trade services was the main contributor to the decrease.
Meanwhile, core PPI, which excludes food and energy prices, showed no change from the previous month, marking the lowest increase in the last four months. On a year-over-year basis, core PPI rose by 2.4%.
The lower-than-expected increase in the Producer Price Index (PPI), mainly the easing in service costs, has heightened expectations that the Federal Reserve (Fed) will implement a 50 basis point rate cut in September. This comes ahead of today's Consumer Price Index (CPI) data release.
At the same time, Fed officials continue to make cautious statements. In a speech yesterday, Atlanta Fed President Raphael Bostic said he needs to see more data before supporting a rate cut. Additionally, Bostic expressed concern about the rise in unemployment. Still, he noted that much of this increase is due to a rising labour supply rather than a decrease in demand. Bostic views this rise as a challenge but calls it a "good problem."
Despite cautious statements from several Fed officials, markets remain convinced that the Fed will prioritize labour market risks and proceed with a rate cut in September as long as the CPI data does not show a significant increase in price pressures.
Market participants expect the Fed to implement rate cuts ranging from 75 to 125 basis points this year. Therefore, today's CPI data will be crucial in determining how expectations will shift within this range, making it a critical factor in pricing global financial assets.
CPI Data Critical for Gold Amid Ongoing Rate Cut Speculation
With increasing expectations for a rate cut, U.S. Treasury yields, which had already entered a downtrend, continued to decline following the lower-than-expected PPI data. The 2-year yields fell to around 3.94%, while the 10-year yields are at 3.85%.
Although the dramatic volatility seen last week due to recession concerns has subsided, the continued pullback in bond yields indicates that lower yield expectations remain intact. This has contributed to sustained demand for non-yielding precious metals.
GOLD was pressured towards its historic high recorded last month but failed to break it. Consequently, today's CPI data could be critical in determining how rate cut expectations shape GOLD pricing.
China's Economic Data to Reveal Ongoing Struggles Amid Housing Crisis and Weak Consumer Spending
Housing prices, retail sales, and industrial production data from China will be released tomorrow. According to median estimates from market participants, industrial production is expected to grow by 5.2%. At the same time, retail sales, despite a slight recovery, are anticipated to increase by only 2.6%, lagging behind industrial activity.
Bloomberg economists suggest that retail sales will improve mainly due to seasonal factors, but consumer spending remains weak. Union Bancaire Privée analyst Carlos Casanova expects the data to reflect a sluggish start to the third quarter and highlights that weak inflation figures pose additional downside risks to the consumption outlook.
Despite the People's Bank of China's (PBoC) surprise rate cuts last month and the government's stimulus package to boost consumer spending in the service sector, consumer confidence has not been significantly impacted.
The housing crisis continues to put pressure on household budgets. According to a Bloomberg Intelligence report, 48 million homes in China have been sold without being completed. The incompletion rate for housing projects in China has surged from an average of 17% of annual sales before 2015 to 47% between 2015 and 2023. Liquidity issues persist despite the government's 300 billion yuan bailout package for the real estate sector.
Economists urge Beijing to introduce more stimulus measures to boost consumer spending, reduce excess capacity, and address local government debt to escape a deflationary cycle. They also emphasize that the People's Bank of China (PBoC) should be less hesitant about further rate cuts, highlighting that heating the economy is more challenging than cooling it down and warning of severe consequences if China falls into a low inflation trap.
Meanwhile, Chinese stocks continue to decline amid economic concerns. The financial reports to be released this week by Chinese internet giants will be closely watched to see if the weakness in consumption is affecting margins and returns on investment.
Yen Rises on Expectations of Diverging Fed and BoJ Policy Paths
The yen is gaining strength amid increasing bets on Fed rate cuts and signals from the Bank of Japan (BoJ) indicating potential further rate hikes. According to Bloomberg data, individual investors' net long positions in the yen have risen by 22% since the BoJ's rate hike last month, reaching 431 billion yen ($2.9 billion).
The BoJ's meager interest rates compared to other currencies had led to significant carry trade operations, where investors sell yen to buy higher-yielding currencies. This practice had been a significant factor in deepening the yen's depreciation.
According to a Bloomberg report, some retail accounts in Japan continue to hold short positions in the yen against high-yielding currencies like the Mexican peso and Turkish lira. However, the report notes that these positions have significantly decreased over the past two weeks.
As expectations for Fed rate cuts increase, anticipation of a narrowing interest rate differential between the BoJ and the Fed fuels bets on continued yen appreciation.
Meanwhile, Prime Minister Fumio Kishida announced in a press conference earlier today that he will not run in the ruling Liberal Democratic Party's presidential election in September.
Following the news, the yen strengthened by 0.3% against the U.S. dollar, reaching around 147.00, while the Nikkei index erased gains and fell by 0.2%.
Kishida's withdrawal has created political uncertainty in Japan, which could lead investors to avoid riskier assets like stocks and trigger further declines in Japanese equities.
Stock Data Boosts Oil Prices, but Demand Worries Persist
Oil prices are recovering from the previous day's losses, driven by the API Weekly Crude Oil Stock report showing a significant drop in U.S. inventories and ongoing tensions in the Middle East.
The API reported a 5.2M barrel decline in stocks for the week ending August 9th, surpassing the expected 2M barrel drop. If the official EIA data, to be released later today, confirms this decline, it will mark the seventh consecutive weekly drop.
However, concerns about demand persist. Analysts highlight that if OPEC follows through with its plan to end voluntary production cuts starting in October, oil prices could decline, particularly given weak demand from China.