PCE Above Forecasts

MACRO FRAME

Fiscal dominance has returned to the market, though underlying concerns over the deficit and debt burden are driving investors to demand more risk premium in an environment with persistent inflation. Meanwhile, yields have broadly taken a backseat to equity market performance as corporate earnings growth and expectations have set up bullish conditions to continue through the remainder of the year.

STOCK INDEX FUTURES

Equity index futures moved lower following July’s PCE release, which showed headline prices coming in above forecasts. Headline PCE index rose 0.2% MoM after falling 0.1% in June, pushing the 12-month rate to 3.7%. Core PCE rose 0.2% MoM at 3.3% YoY reaffirming still-firm inflationary pressures. While near-term rate hike expectations have not shifted dramatically in response to the report (40% chance of hike in September), market sentiment negatively to the view that the Fed could be raising rates by year-end. Second estimate GDP growth came in line with expectations real GDP held at 1.5%, but real final sales to private domestic purchasers was revised up to 4.2%, while the GDP-based PCE deflator and core PCE deflator were revised higher to 5.3% and 3.6%, respectively. Taken together, these reports are hawkish and likely to affirm views on the FOMC board that policy should move upwards.

After the bell Nvidia will report quarterly earnings in a report seen as the next major test of the AI trade. Investors will be looking for strong earnings targets and evidence that revenue streams have diversified. Nvidia’s report is less about whether it beats the consensus targets and more about whether it validates a durable, broadening AI-infrastructure investment cycle into 2027. Broadly, the market is looking to see whether hyperscaler capex is generating multi-year revenue streams and broadening customer demand for the tech sector.

Watch point: Despite tech volatility, the earnings backdrop suggests bullishness, though a September rate hike remains a near-term risk.

CURRENCIES

US DOLLAR: The USD index is sharply higher at 99.04, gaining on the heels of July’s PCE and revised Q2 GDP data, which affirmed inflationary pressures in the economy. Still, near-term pricing for a September rate hike has little changed, which is likely keeping a cap on the dollar’s upside. In order for the dollar to continue to the upside, money markets will need to shift hawkishly and reduce implicit year-end policy spreads. Broadly, the dollar is still under pressure from moves to diversify away from the currency amid worries the deficit, reflected in yields at the long end of the curve. The Treasury’s move to put a bottom on prices also  means that the dollar is likely to be under pressures because if bond prices cannot move lower naturally, the foreign exchange price of owning US debt will price it out via currency depreciation. Investors will await the Jackson Hole Symposium for further clues on Fed policy, though Warsh is unlikely to tip his hand. Still, any opinion on the Treasury’s move that could restore confidence in the Fed could boost some confidence in the dollar.

Watch point: The market remains doubtful over a September hike, though the risk of a move upwards in policy should not be discounted given the current inflationary backdrop.

EURO: The euro moved 0.15% lower to $1.1655 in response to the US inflation data. Germany saw a raft of positive data on Tuesday, which moved German 10-year Bund yields to a 15-year high and firmed up ECB rate hike expectations offering tailwinds to the euro. Reuters reported overnight that ECB policymakers are ready to raise rates at the September meeting due to side-effects of higher energy prices, but that policymakers will signal little intent to further rate hikes. Money markets are pricing an 95% chance of a hike in September against 40% for the Fed, so the report did not take the market by surprise. Traders are pricing around 40 bps of tightening this year. Given that the eurozone economy has proved remarkably resilient and that natural gas prices are driving up energy costs, the base case for September is that the ECB will hike rates with little worry of negative effects to the economy.

Watch point: Broader price direction will be subject to Fed-ECB policy expectations, which is likely to be favorable to the EUR in the near-term.

BRITISH POUND: Sterling is 0.31% lower at $1.3607. With no new Uk data out, the market will focus on US developments in the wake of PCE data ahead of the beginning of the Jackson Hole Symposium on Thursday. Recent economic data has been positive and kept market expectations of at least one Bank of England rate hike in place. However, labor data pointed to a broad cooling in hiring and wage pressure, reinforcing our view that the BoE will remain on hold through the end of the year. Markets are priced for 24 bps of tightening by year-end and see a 52% chance of a hike come November.

JAPANESE YEN: The yen is little changed at 159.28 yen per dollar. The recent decline in oil prices over the last few days has kept the yen in check, though the currency largely been in a holding pattern over the last couple of weeks as investors await the Bank of Japan’s September meeting, where it is expected to raise rates. Markets are pricing a 68% chance of a September hike. July’s meeting minutes revealed more urgency to raise rates, but a failure to validate market expectations of a September hike could renew pressure on the currency and send the yen back toward the 160 area. Bank of Japan Deputy Governor Ryozo Himino will speak later tonight, his speech will be closely watched for signs if he pushes back on market pricing of a faster rate of hikes from the BoJ. Stronger near-term rate hike expectations have kept the yen from sliding as fast as it had been earlier in the summer, though existing fundamental pressures remain. Mounting unease over Japan’s fiscal outlook has kept JGB yields elevated without offering the yen support, highlighting market worries over the debt-load.

Watch point: Failure to raise rates at the Bank of Japan’s meeting could see the yen drop toward the 160 level.

AUSTRALIAN DOLLAR: The Aussie is 0.22% higher at $0.7178 as monthly inflation data showed prices rose 1.0% in July, above forecasts for a 0.8% rise. Trimmed mean inflation rose 0.5%, above expectations of a 0.3% rise, keeping the annual pace at 3.6%, where the Reserve Bank of Australia had been looking for a slowdown toward 3.3% by year-end. Minutes of the Reserve Bank of Australia’s August meeting showed that several members were pushing to hike rates, however, noted that upcoming data on inflation, jobs, and GDP ahead of September’s meeting would be needed to further assess the economy. Taken together, this has set up September’s meeting to be more lively than expected. Money markets now see a 40% chance of a hike at the September meeting vs. pricing of a 14% chance yesterday morning.  Weak labor data has suggested some softness in the labor market, though the data is unlikely to weaken the RBA’s tightening bias heading into Q3 inflation figures.

Watch point: June’s hiring figures have offered some relief on inflationary pressures, though ongoing pass-through into broader prices is likely to be in focus in upcoming data.

TREASURY FUTURES

Yields are higher across the curve, with the rise most reflected in the belly. July PCE reinforces the view that inflation remains too firm for the Fed to not move higher on rates before year-end. Both headline and core PCE prices increased 0.2% in July, leaving YoY rates at 3.7% and 3.3%, respectively. While real consumer spending was flat, real disposable income continued to rise, limiting evidence of a material deterioration in household demand. The combination of subdued real activity and sticky inflation should keep policy easing constrained and supports a hawkish market reaction. The second estimate GDP figures leaves headline output growth unchanged at a moderate 1.5% annualized rate, but the details are inflationary: private domestic final demand was revised to a robust 4.2%, real GDI rose 2.2%, and PCE inflation was revised higher. The report therefore reinforces the message from July PCE that the economy retains enough domestic-demand resilience to keep inflation risks elevated and heighten expectations the that Fed should move upward on policy.

Elsewhere, the Treasury said it could use the Treasury General Account to purchase longer-dated bonds, which could lead to the scenario of that the market believes the Treasury is defending a price. That dynamic could see the market test of the Treasury’s move, leading the buyback operations to grow overtime. Bond prices likely to remain under pressure through the rest of the year as underlying problems of a rising deficit, massive debt load are driving an increase in risk premium despite efforts from the Treasury. Inflation expectations have been relatively contained, signaling that upcoming bond market volatility is likely to center around the political environment in the US and November mid-terms. Meanwhile, the addition of rising supply of corporate bonds and persistent inflationary worries set up conditions for yields to resume their uptrend. Markets are pricing a 40% chance of a hike next month and see 24 bps of total tightening by year-end. The  Jackson Hole symposium will see traders look for guidance over the recent climb in yields and for reassurance of Fed policy from the Trump administration. Failure to address near-term issues without any material plans from the Fed is likely to add to bond market unease.

Watch point: For Fed policy, without any forward guidance, the September decision will likely remain a close call.

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