Morning Brief – A closer look

Charles Porter
Thu 10 Aug 2023

A closer look

Having signalled the importance of the US data due to be released today, it’s time to take a closer look at what’s expected. With significant US bond auctions still taking place this month, market attention to US treasuries still remains as close as ever. Today’s data will be seen as perhaps not the latest but likely biggest piece of the puzzle for forecasting the Fed’s path from here on. As a reminder of what the bond market is trying to decide, recall that the debate currently dominating markets is whether the Federal Reserve has concluded its hiking cycle following its last hike in July that brought US rates to their highest level in 22 years. Over the past few weeks, the dominant expectation is that they have finished with only rate holds and cuts priced into the curve in the United States. 

There will therefore be the benefit of confirmation bias for today’s data due to be released at 13:30 UK time. The burden of proof to move incumbent pricing will also be to the upside that inflation continues to outpace expectations. So, what are we looking for? There will be a headline inflation figure released that is largely unimportant. It will show year-on-year inflation and core inflation figures expected at around 5% and 3% respectively. A miss of the forecast could create volatility in isolation without doubt, but I contend that the usually lower salience month-on-month figures will be more important. Here’s why:

There are two ways to observe annual inflation. The first and most traditional is inherently backward looking. It is statistically sound but can only tell you the difference in price level today vs that a year ago and is referred to as ‘year-on-year’ inflation. It’s great for looking at long term trends but shows us little about the year ahead which is more often than not what we care about. Instead, you can annualise a shorter observation period of price change to get a more current snapshot of inflationary trends still comparable at an annual level.

The most common form of this is annualised month-on-month inflation. This considers what is the price level change this month versus last, multiply by 12 to scale up to a yearly figure and account for seasonality and compound effects. This should provide us with a more timely snapshot of inflation pressures. There are downsides to this statistic, namely the errors inherent with projecting annual inflation from only two observation points a month away. Small monthly variations from short-term supply and demand factors can over or understate an underlying or fictitious inflation problem. However, it is undeniably more useful for understanding present inflation pressures than its year-on-year counterpart. Month-on-month inflation will also be read today and is expected to show a figure of 0.2%. Multiply that by 12 and it’s plain to see we are very close to the Fed’s target 2% of inflation. If expectations are confirmed by the data, this could be the final signal to confirm the Fed’s cycle is over. 

Discussion and Analysis by Charles Porter

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