The US dollar faces trial by fire today with the release of the latest CPI report, which will reveal whether inflationary forces have finally started to lose their punch. That is the consensus among economists, who collectively expect the yearly CPI rate to decline to 8.7% in July from 9.1% previously, hopefully marking the long-awaited ‘peak’ in inflation.
US inflation test
Several elements point to a moderation in price pressures. Business surveys from S&P Global suggest that companies raised their selling prices at the slowest pace since last March as demand softened, shipping rates have started to cool, and a range of commodity prices from energy to food to metals have rolled over.
Even so, the inflation scare is unlikely to fade so easily. The core CPI rate, which strips out food and energy items, is anticipated to have risen further in yearly terms. That would imply that even though commodity prices are simmering down, the battle to eradicate inflation still has a long way to go, keeping the Fed on the warpath.
Money markets are pricing in a 70% probability for a three-quarter point rate increase by the Fed in September and 30% chance for a half-point move, which suggests that a disappointment could inflict more damage on the dollar than a positive surprise can boost it. That said, even if euro/dollar rallies all the way up to $1.05, some 300 points away, it would still be in a downtrend.
Nasdaq hits turbulence
Wall Street encountered turbulence on Tuesday and lost some altitude, with chip designers such as AMD and Nvidia spearheading the retreat after a revenue downgrade from memory-maker Micron Technology sent shivers down the spines of investors. Micron’s alert came hot on the heels of a similar warning from Nvidia, sparking concerns of a microchip glut since demand seems to be cooling right as more supply is coming online. On the bright side, an oversupply of chips would ease the disruptions that have kneecapped global supply chains for the past two years and help counter inflationary pressures, so it is not all bad news for the equity markets.
The near-term performance of the major US indices will hinge on the upcoming inflation print, but in the bigger picture, the recent rally seems a little overextended in an environment where the bond market is screaming recession and inflation-adjusted earnings growth is contracting.
China's gray swan
Over in China, the latest batch of inflation data fell short of expectations, with producer prices losing steam in a sign that factory demand is struggling. Overall, the situation in the world’s second-largest economy is very worrisome, as the debt-fueled growth model that enabled the nation’s economic miracle seems to be unraveling.
The property sector is tanking, with liquidity drying up and a ‘mortgage revolt’ underway as homeowners increasingly refuse to pay loans on unfinished houses. It doesn’t take much imagination to envision this crisis infecting the banking sector, which is tremendously leveraged at almost 300% of GDP, without even including shadow banking.
With property accounting for one-third of the Chinese economy and interest rates abroad marching higher, exacerbating the pressure on distressed developers, this has the characteristics of a ‘Lehman-style’ moment that could infect the global financial system. Now to be clear, this is merely a risk. It may never fully materialize, and even if it does, the government might be able to stop the contagion. Nonetheless, it is worth keeping a close eye on, as it could have tremendous repercussions for every single asset class.
