Week Ahead: UK inflation and hints about the Fed’s next move

Can stock markets continue to rally? 

What a difference a week makes. Post last week’s weaker than expected July inflation print for the US, which saw annual headline CPI fall to 8.5% from 9.1% in June, the first positive inflation surprise for quite some time, and the market is in risk-on mode. Stock markets reached another milestone last week when the Nasdaq Composite index rose more than 20% from its mid-June low, to end its longest bear market since 2008. Added to this, the dollar has sold off sharply since its mid-July peak, with the dollar index losing 3%. The dollar had been inversely correlated with US stock markets for most of this year, thus, market bulls are looking for further dollar weakness if the stock markets continue to rally. However, the question now is, will the bull market continue? There seems to be two camps out there right now. On the one hand, those who think that the worst of the year’s market sell-off is behind us, now that US inflation looks like it has peaked, and on the other hand, those that are still concerned that the Fed has not finished its interest rate hiking cycle, that inflation is still too high and that the recent uptick in stocks is merely a bear-market rally, albeit an aggressive one. This week’s global economic data may determine who is right. 

Below, we look at three events that could determine the direction of stocks and other risky assets this week. 

1. FOMC minutes 

There are two main pieces of data that we will be looking at this week, including the minutes of the July Federal Reserve meeting and US retail sales. The market had, on balance, concluded that the Fed’s press conference after the July meeting was dovish, with Fed chair Powell ditching forward guidance, refusing to rule out a smaller rate hike at future meetings and his comment that US interest rates at 2.25-2.5% was within the ballpark of neutral Federal Reserve interest rates. This was surprising to some, since at that time US inflation was at a more than 40-year high of 9.1%. However, last week’s cooler than expected inflation rate means that the next FOMC meeting will most likely go down to the wire, with the Fed expected to look closely at August NFPs and the August CPI report. The market has taken a dovish turn when it comes to the Fed’s next rate hike, there is now a 55% chance of a 50bp rate hike at the September Fed meeting, and a 45% chance of a 75bp rate hike. This is down from a 68% chance of a 75bp rate hike for September, just one week ago. Thus, this week’s minutes will be important to watch closely. Does the Fed really think that US interest rates are close to neutral and how much do they want to see inflation fall before they stop hiking rates? These will be important questions in the week ahead. They will determine if the Nasdaq can extend its recent 20% rally, and if some of the weaker US stocks, including meme stocks like AMC, can also continue their recovery. It will also determine the direction for the price of gold, along with the dollar. After the supposedly dovish press conference at the July meeting, the question now is, will the minutes throw a hawkish cat among the pigeons? If so, EUR/USD’s recent rally could be at threat after this pair failed to break $1.0270 resistance at the end of last week. 

2. US consumer resilience 

US retail sales, released on Wednesday, will also be watched closely as the market expects a slowdown of sales ex autos to -0.1% in July, after a 1% rise in June. However, the steeper than expected decline in US CPI last month, could boost sales. Added to this, there was an increase in the University of Michigan consumer sentiment survey that was released at the end of last week. Longer term inflation rates came down, with consumers expecting inflation next year to be 5%, down from 5.2% in July. Interestingly, consumers’ economic expectations edged up in August, according to the survey, particularly among low- and middle-income consumers, who are sensitive to inflation. This doesn’t mean that inflation is no longer a problem, 48% of respondents to the survey still blamed inflation for eroding their living standards, however, it suggests that there is a risk of an upside surprise to this week’s US retail sale figures on the back of falling gas prices. 

2. UK CPI 

Unlike the US, we do not expect the UK to follow suit and see a sharp decline in inflation for July. While economists expect inflation to remain flat on the month at 0%, the annual rate of headline CPI is expected to rise to 9.8% from 9.4% in June. Core consumer prices are also expected to rise to 6.4% from 5.8% in June, which is likely to keep the BOE on edge about the passthrough effects of rising prices. However, anyone who buys petrol in the UK, may have noticed that prices have come down rapidly in recent weeks, thus, while the July figure is strong, it could essentially be the peak for inflation in the UK, at least for a few months. W    hile the market will use the latest CPI data to decipher what the BOE does next, the truth is, this data is not the only factor at play for the BOE. Due to the way that the UK energy market is structured, along with the continuing fall out from Brexit, the current UK inflation outlook is significantly worse than its G10 peers, with inflation expected to stay higher for longer. However, recent reports suggest that the government are looking at ways to freeze the energy price cap for the next two years; if that happens then we could see a significant decline in UK CPI expectations, which would lift the pressure from the BOE and help the UK economy in the long term. Thus, keep an eye on this week’s CPI report, but remember that other factors are also at play when it comes to the future direction of UK interest rates and thus the UK economy. 

4. UK consumer: just how hobbled are they? 

We will also be watching UK retail sales report for July, that is scheduled for release on Friday. The market is expecting sales ex-autos to fall by 0.2% in July, however, like the US there is room for an upside surprise. Although the outlook for the UK consumer is challenging, the BRC retail sales report suggests that “hot weather spending” on clothes, fans and food and drink could have helped boost sales last month. However, even if we do get an upside surprise in UK retail sales for July, the biggest factor that could move the dial for the pound, would be a solid move by the government to freeze the energy price cap. Watch this space…