US inflation drops and the markets like what they see (at the moment). The TPP midweek commentary.

US Inflation drops to 2.5%.

Most of the data earlier this week was just a run-up to the US inflation release so let’s start with that.

The good news is Inflation in August declined to its lowest level since February 2021, according to the Labour Department report Wednesday setting the stage for an expected quarter percentage point rate cut from the Federal Reserve.

The consumer price index, a broad measure of goods and services costs across the U.S. economy, increased 0.2% for the month, in line with economic consensus.

The annualised CPI number came in at 2.5% compared with July’s 2.9 per cent, and was marginally below the estimate of 2.6 per cent from economists polled by Reuters. The inflation data marks one of the last major economic releases ahead of the Fed’s meeting on September 18 and paves the way for an expected quarter-point cut to interest rates, which are currently at a 23-year high of 5.25 to 5.5 per cent.

The evidence that inflation is moving towards the Fed’s 2 per cent target is welcome news for the White House and the election campaign of vice-president Kamala Harris, who has been attacked by her Republican rival Donald Trump over the US cost of living crisis.

“Disinflation is an imperfect journey but it’s certainly happening,” said Kristina Hooper, chief global market strategist at Invesco. “I think [the September cut is] going to be 25 basis points because I do believe the economy is on relatively solid footing.”

Core CPI, which excludes volatile food and energy prices, held steady at 3.2 per cent, according to data published by the Bureau of Labor Statistics. Compared with last month, core prices were 0.3 per cent higher, slightly faster than economists expected.

US stocks dropped on the news with the S&P 500 down 1.6 per cent by the late morning in New York and the tech-heavy Nasdaq Composite was 1.3 per cent lower. What followed can only make sense in American equity markets. After a drop of 1.3 per cent, the Nasdaq ended the day higher by 2.17%.

In what can only be described as a day of two halves we saw a collapse in all major stock markets on the US open only to see a rebound that was even stronger.

In government bond markets, the two-year Treasury yield, which closely tracks interest rate expectations, reversed course during morning dealings to trade 0.02 percentage points lower at 3.59 per cent only to then rally back up to 3.66. The benchmark 10-year yield was 0.01 percentage points higher to trade flat against the 2-year at 3.66 per cent.

It’s worth noting that traders increased their bets on a quarter-point cut next week after the inflation figures were published, raising the implied probability of such a move from about 70 per cent to as much as 85 per cent. But although traders have retreated from earlier expectations of a half-point cut, Fed funds futures markets still anticipate that rates will come down by a full percentage point by the end of the year.

The pan-European Stoxx 600 whipsawed on the inflation news moving from positive, to negative and positive to close pretty much flat on the day. We get used to these moves on US figures. The old saying, ‘When America sneezes, the world catches a cold’ is no truer than in financial markets.

At the close the FTSE 100 and the French CAC closed down -0.14% and -0.15% respectively while the DAX in Germany managed a small gain of 0.34%.

However, as the US markets rallied in their afternoon trading sessions so did European indices. At the close of play on Wednesday night, FTSE futures were trading up 0.62% at around 8272. The CAC was 0.77% higher while the DAX was up even more with a jump of 1.20%. It will be interesting to see if European markets can hold onto these gains at Thursday’s open.

Earlier this week we also saw UK unemployment drop for July from 4.2% to 4.1% and average earnings continue to come in above inflation at 4%. The other data of note this week was that UK GDP flatlined in July, making it the second month in a row and coming in under market expectations of 0.2%.

In the three months to July, the UK economy 0.5%. The services output, however, did tick up 0.1% in July after falling 0.1% in June, making for a three-month growth of 0.6%.

Production output, however, fell 0.8% in July, while construction reduced by 0.4%. Over three months, construction did grow by 1.2%, which the Office for National Statistics noted was the first positive growth over three months since September 2023.

Liz McKeown, director of economic statistics at the ONS, said: "July’s monthly services growth was led by computer programmers and health, which recovered from strike action in June. These gains were partially offset by falls for advertising companies, architects and engineers.

"Manufacturing fell, overall, with a particularly poor month for car and machinery firms, while construction also declined."

In equity markets, Rightmove ticked up after it rejected a £5.6bn takeover proposal from Australian peer REA Group, labelling it "wholly opportunistic" and saying it undervalues the UK property platform’s future prospects.

Trustpilot rallied as it said first-half profit was ahead of market expectations and announced a further £20m share buyback.

WH Smith gained as it reiterated its full-year outlook and unveiled a £50m share buyback after a buoyant fourth quarter. The retailer said group sales rose 6% in the three months to 31 August, which includes its peak summer trading period, or by 4% on a like-for-like basis.

Rentokil tumbled as the pest control firm scaled back its profit guidance for the full year after weaker-than-expected summer trading in North America.

Dunelm lost ground as it reported a rise in full-year profit and sales despite a "softer" market and said it continues to see "a challenging consumer environment" and that the timing of a sector recovery remains uncertain.

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It will be interesting to see how the European markets open today, after the late surge in US equities, and a strong Asian session.

Many of our strategies are positioned on the Long/Buy side of the market at the moment, but will some profits be taken on some of the trades if momentum follows through? I guess we'll find out soon.

Enjoy the rest of your week.