US index futures breakout on a sharp fall in US CPI

What a difference a week makes! This time last week, markets were having kittens over a sharp move higher in bond yields. The hawkish lean of the FOMC minutes sent Treasury yields sharply higher, and risk appetite was looking decidedly wobbly. However, since then, a rather tepid Nonfarm Payrolls report forced a rethink on the outlook for Fed rate hikes. Today’s US CPI has accelerated the thought process that perhaps the Fed will not need to be as hawkish as some had positioned for. The net result is that a correction on US index futures has been turned on its head, with breakouts to new multi-month highs once more.

Downside surprises for US CPI. The US CPI inflation data has come in lower than expected in June. The headline US CPI has dropped to 3.0% from 4.0% in May. This was below the already sharp decline to 3.1% that had been forecast. Perhaps more interestingly also, the Core CPI (adjusted for food and energy) reduced to 4.8% from 5.3% in May. The consensus had forecast a drop to 5.0%, so this decline is eye-catching, especially for the Fed, which has been so concerned by core inflation remaining stubbornly high. The core CPI accelerating lower is the standout news here. It will also mean that traders will be focusing on the US PPI inflation tomorrow. The core PPI has been leading other inflation data lower and is expected to fall to 2.6% (from 2.8%).

This will impact the Fed, but not yet. This is the news the Fed would have been hoping for. After hiking by +500 basis points in this rate tightening cycle (the most aggressive tightening for four decades), the Fed would rather not have to tighten much more if it can help it. Inflation is now decisively falling and for the past two months has been lower than forecast on the CPI. The FOMC dot plots guided for two more 25 basis points hikes this year. Fed Chair Powell has been hawkish in backing this view in the Congressional testimonies and at the Sintra forum of central bank chiefs. However, more recently, Fed speakers (such as Mary Daly and Michael Barr) have been slightly less hawkish, suggesting the end to tightening was close. The key will be after a relatively subdued Nonfarm Payrolls report has been followed by another lower-than-expected US CPI, will this give the FOMC doves more of a voice? There are only two more trading days after today before the FOMC goes into its Blackout period ahead of the meeting announcement on July 26th. This has come as CME Group FedWatch continues to price for the strong possibility (currently a 92% probability) of a 25 basis points hike in the meeting in a couple of weeks. However, it is now struggling to believe there will be any more. Furthermore, the prospects of rate cuts resuming in either the March or May FOMC meetings in 2024 are rising to almost 70% in March and as much as 94% in May.

Bond yields are falling hard. There is a big reaction in major markets, being driven by moves in Treasuries. Bond yields have now all but entirely retraced the sharp move higher that came in the wake of a hawkish set of FOMC minutes last week. The US 10-year Treasury yield, which had spiked from around 3.85% to 4.09% in a couple of sessions, has now retraced almost all of that move. The 2-year yield hit a high of 5.12% on Thursday, July 6th, and has unwound to 4.74%. Losing around -35bps in a week is a big retracement. The move has broken a two-month uptrend and means that traders will be keeping an eye on 4.65% as the next key low.

Completing breakouts on US index futures. With yields falling decisively in recent days, driving the USD lower, this is also fuelling strong gains once more on US index futures. The e-mini S&P 500 futures had been corrective until the payrolls report. However, the bulls have returned in force to leave a key higher low at 4411 to break out once more to a new high above 4498. The uptrend is still in place, and the run of higher lows continues. The March 2022 high of 4631 is the next important line of resistance. I have previously warned about the negative divergence on the Relative Strength Index. This is where lower highs on the RSI come at the same time as higher highs on the futures and warn of faltering momentum). This divergence is still in place for now, but if the futures continue to move higher, it would be likely that this divergence will be aborted. It is a similar picture also on the e-mini NASDAQ 100 futures. A corrective move from early last week has turned sharply higher from a low at 15063. The move has today broken out above the resistance at 15432. This continues the run of higher lows and higher highs in this accelerating bull market. The next resistance is 16009 before the key Q4 2021 highs of 16660/16767. As with the S&P futures, I am still keeping an eye on what continues to be a prospective negative divergence, but for now, the bulls remain in control.

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