US – September cut in sight
Inflation surprised to the downside last week, as headline prices fell by -0.1% MoM and core prices rose only by 0.1% MoM. The slowdown was broad-based, but most importantly shelter inflation finally slowed to 0.2% MoM, the smallest increase since early 2021. Combined with PPI inflation, core PCE inflation is now estimated at around 14-18bp MoM for June. Ahead of the print, Powell had already spoken about encouraging progress with disinflation during his congress testimony, while Goolsbee described the new print afterwards as “excellent”. Following the softer labour market, the new inflation reading clears the way for a first Fed cut in September. The market is implying >90% odds for the September cut and assumes cuts at every other meeting thereafter. If the labour market was to weaken further, the risk becomes cuts at back-to-back meetings. Terminal rates are priced at 3.5%.
ECB – Meeting Preview
The ECB will hold rates on Thursday, following their cut in the prior meeting in June. Recent inflation readings have remained firm, with core inflation unchanged at 2.9%. ECB speech at Sintra was cautious, and it’s likely the ECB waits until September to justify another cut with new projections. Markets assign 85% odds for a cut in September and see roughly 2 cuts in total by year-end.
Outlook – Demand for carry trades
The summer months are typically positive for carry trades, but geopolitical volatility has kept investors on alert since June. Initially driven by the surprising supermajority outcome in Mexican elections, the unwind of popular LatAm-FX trades led to a broader unwind of carry trades across FX. French elections brought back Eurozone risk premia, stopping investors out of EGB credit spread compression trades. Demand for carry trades has quickly come back with most events out of the way, but we caution that risk premia including implied volatilities are looking low once again, with e.g. VIX at only 12. Key question marks for July and August include the formation of a French government, the runup of the US elections and the slowing of US economic data.
Algebris Investments’ Global Credit Team
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