US inflation falls to two-year low in May

US inflation fell to a lower than expected 4.0% y/y in May from 4.9% in April, largely due to lower energy costs and slowing food inflation. While the headline rate was the lowest since March 2021, core inflation rose 0.4% m/m and 5.3% y/y, only a modest improvement from April’s 5.5% y/y reading. Used vehicle prices posted a 4.4% m/m rise in May after a similar gain in April, but are expected to soften in the coming months. Services inflation (excluding energy) remains elevated at 6.6% y/y, driven by higher housing (8.0% y/y) and transportation (10.2% y/y) costs. Given that the May inflation data was broadly in line with expectations, and shows price growth moving (slowly) back towards the 2% target, the Fed will likely keep rates unchanged today. However, high services inflation, combined with a tight labour market and robust wage growth may persuade some policy makers that another 25bp rate hike is warranted next month. This would be reflected in the new dot plot, also due today.

UK unemployment declined to 3.8% in the three months to April from 3.9% previously, defying expectations for a rise to 4%. Employment rose by a much higher than expected 250k in the three months to April. The tighter labour market, and in increase in the National Living Wage that came into effect on 1 April, was reflected in average weekly earnings growth of 6.5% y/y in the three months to April, up from 6.1% in March. The March figure was also revised higher. The labour market data supports our view that the BoE will raise rates again this month to 4.75%.

Germany’s ZEW survey showed an improvement in investor expectations in June. The expectations index rose to -8.5 from -10.7 in May, above the median forecast. However, sentiment around current conditions worsened with manufacturing still firmly in contraction territory. Higher borrowing costs – the ECB is expected to hike again this week – are a further headwind to recovery after the economy entered a technical recession in Q1 2023.      

Today’s Economic Data and Events

• 10:00 UK April GDP (3m/3m) forecast 0.1%
• 10:00 UK Industrial Production (Apr) forecast -0.1% m/m and -1.7% y/y
• 16:30 US PPI (May) forecast -0.1% m/m and 1.5% y/y
• 22:00 FOMC rate decision (upper bound) forecast 5.25%

Fixed Income

• US Treasuries traded in a highly volatile day. After initially rising on the back of the May CPI print—where headline inflation slowed to its lowest level since Q1 2021—Treasuries then dropped over the rest of the day with 2yr UST yields showing about a 20bps round trip from bottom to top. A strong UK labour market print may have been behind the move as gilts had a massive sell-off overnight.
• Yields on the 2yr UST closed the day up 9bps at 4.6662%, hiding some of the intraday volatility while the 10yr added 8bps to 3.8133%. The Fed concludes its June FOMC meeting this evening with a negligible chance of a hike priced in for today while prospects for a July move have also edged lower.
• Gilt yields soared on the back of strong labour market data in the UK. Yields on the 2yr yield rose 26bps to 4.872% while the 10yr added 9bps to 4.425%. European bonds generally pulled weaker as well with bund yields up 4bps at 2.417%.  

FX

• Currencies pushed higher against the Fed overnight as rate expectations tempered somewhat. EURUSD rose by 0.3% to 1.0793 while GBPUSD jumped 0.8% to 126.12. USDJPY, however, rose by 0.4% at 140.22. Markets will likely trade sideways somewhat until the outcome of the FOMC this evening.
• Commodity currencies all had a strong day with USDCAD down 0.4% at 133.18 while AUDUSD added 0.2% to 0.6767 and NZDUSD rose 0.4% to 0.6149.

Equities

• Japan’s Nikkei index continued its strong run yesterday as it added 1.8% on the day to close above 33,000 for the first time since 1990. The Topix also performed well as it added 1.2% but elsewhere in East Asia gains were more muted as the Hang Seng added 0.6% and the Shanghai Composite 0.2%.
• In the US, the slower inflation print for May led to gains in the key equity indices, with the interest-rate sensitive NASDAQ adding the most at 0.8%. The S&P 500 closed up 0.7% and the Dow Jones 0.4%.
• Locally, the DFM ended the day 0.2% higher while the ADX dropped 0.2%. Saudi Arabia’s Tadawul closed up 0.3%.

Commodities

• Oil prices recovered much of the prior day’s heavy losses overnight with Brent up 3.4% at USD 74.29/b and WTI gaining 3.4% to settle at USD 69.42/b. Receding expectations of rate hikes along with China indicating it was likely to offer support to the economy seemed to support sentiment around commodities.
• Data from the API showed a build in US crude stocks of 1m bbl last week along with increases in gasoline and distillate inventories.