Asian markets are poised to jump on Wall Street's rally after the latest U.S. inflation data raised hopes that the Federal Reserve may finally ease monetary policy in September.
Futures in Tokyo, Hong Kong and Sydney are showing encouraging signs after a sharp rally on Tuesday, when regional benchmarks surged to pre-Aug. 5 sell-off highs. This is not just a bounce, suggesting the soft landing thesis is not just wishful thinking. After briefly flirting with recession fears last week, core optimism remains strong, with a more than 50 percent chance of the Fed cutting interest rates by 50 basis points in September.
Markets are recovering nicely from the recent storm of volatility, with the cause becoming clearer with each passing day. Once the cause is identified, the element of surprise will disappear and the volatility will disappear. The turmoil appears to be due to the unwinding of heavily leveraged positions, rather than genuine fears of an impending economic downturn.
While the Producer Price Index (PPI) often plays a supporting role compared to the main player in the inflation data drama, the Consumer Price Index (CPI), its impact on market mood is undeniable. In an era when the Fed can fine-tune its forecasts by a tick, even this subtle indicator can surprise traders. So when the PPI came in weaker than expected, it triggered a whisper-like, violent rally. Ever-nervous market participants took this as a signal to recalibrate their bets on interest rates, proving once again that even the softest notes can ring out loud and clear in the financial symphony.
While we are not yet in the “hope carefully” phase of the inflation cycle, there is growing concern among market participants that the US economy may not be as robust as it appears. The concern? That inflation could fall below the sweet spot, raising calls for an “insurance cut” of -25bp on top of the base rate. This additional 25bp cut is not intended to bail the economy out of a bind or avert a recession, but rather to avoid a scenario in which the Fed tightens real policy rates without taking direct action as inflation retreats. This strategic maneuver is intended to stay one step ahead and ensure the Fed does not get cornered into a corner where passive rate cuts become an unwelcome reality.
