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MARKETS

The US CPI data, which came in below expectations, has sent rate-cut ripples across global markets. This better-than-expected inflation reading opens the door wide for a September rate cut from the Fed. The report strongly suggests that consumer inflation has swiftly resumed its downward path after an unexpected surge in the first quarter and is likely on its way to a sustainable 2.0%. And given the recent trend of softer US economic data, half of Wall Street is now leaning towards the Fed implementing three rate cuts this year.

Despite the promising inflation report, US stocks took a tumble on Thursday as investors shifted away from tech. The S&P 500 dropped 0.8%, falling below 4,600 after briefly crossing this level on Wednesday. Heavyweights like Nvidia (NVDA), Microsoft (MSFT), and Meta (META) all slid, causing a ripple effect across the so-called AI 5.

If we are looking for a culprit, perhaps concentration risk ahead of earnings season. The real question is, what's already "priced in"? And let’s be honest, there’s a steep drop at the index level in the offing if any AI heavyweights deliver a “bad” guide.

When the mega caps dive, S&P 500 and Nasdaq investors scramble for a life preserver to stay afloat. And for those quick enough on the rotation, small caps provided the interday buoyancy.

The Russell 2000 index was up over 3% as investors sensed rate cut relief was on the way. This "Alka-Seltzer moment" was much needed for small caps, shackled by higher short-term rates. The rude health of S&P large caps, which managed to borrow fixed in 2021, belied the funding pain further down the market cap ladder. So, hooray for the small guys today.

FOREX MARKETS

While Big Tech was slinking lower, the real showstopper was the cliff drop in USD/JPY, which plummeted four big figures and caught many FX traders off guard, suggesting a possible rate check by the Bank of Japan( BoJ).

However, when the even odds probability of three rate cuts hit FX Desks, several big sell orders hit EBS almost simultaneously, triggering a stop-loss domino effect in the e-FX space, driving the pair down to 157.42.

The stop-loss narrative, rather than a BoJ rate check, makes more sense, given that speculative traders have accumulated massive bearish bets against the Japanese currency. With a third US rate cut starting to firm up, those who jumped on the long USD/JPY bandwagon above 155 will look increasingly prone to another stop-loss run if the BoJ stirs the policy pot or GPIF whispers grow louder.

Our fear of the Trump inflationary trade reaccelerating and the possibility of the OAT-Bund 10-year spread rewidening amid French political gridlock keeps us cautious on big dollar shorts. However, we felt backing up the truck on gold was the cleanest and least bothered way to express US rate cut fever, and the yellow metal should carry its weight through the US election fracas.

NUTS & BOLTS

The CPI release prompted a dramatic repricing across the US rates complex. Consistent with the read-through of another downside inflation surprise for Fed policy, the move was most pronounced at the front end. Two-year US yields dropped 14bps through midday, marking the biggest rally of 2024. Further out, 10s rallied 10bps, down to ~4.18%, near the lowest since early March. The curve bull-steepened, indicating that the front end anticipates Fed cuts.

The opinion across trading desks was swift and unanimous: The Fed will cut in September. Market pricing for the Fed trajectory shifted aggressively in the wake of the CPI release.

Traders, who’d already fully priced two cuts, now see even odds of a third. The June dot plot is now so stale it's virtually meaningless.

In summary, the three-month pace of core price growth in the US is basically mandate-consistent at 2.1% annualized. So buckle up and keep your sense of humor—it will be fun.

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