By Jamie McGeever
ORLANDO, Florida (Reuters) -TRADING DAY
Making sense of the forces driving global markets
By Jamie McGeever, Markets Columnist
Surprisingly soft U.S. producer price inflation figures on Wednesday spurred outside bets on a half a percentage point cut in U.S. interest rates next week, pushing Wall Street to new highs, lifting gold, and pulling bond yields lower.
In my column today I look at how the combination of Fed rate cuts and sticky inflation will reduce ‘real’ U.S. rates and yields, spelling bad news for the dollar.
If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.
Today’s Key Market Moves
Today’s Talking Points:
* Tech booming … agAIn
The extraordinary 43% surge in Oracle’s share price thrusts the whole AI bubble debate back into the sharpest focus. This is not a penny stock, startup or meme stock, this is a long-established tech giant, which is now suddenly close to joining the exclusive $1 trillion market cap club.
Oracle said on Tuesday it expects booked revenue at its Oracle Cloud Infrastructure business to exceed half a trillion dollars. Shares traded at nearly 50x estimated 12-month forward earnings on Wednesday, the highest since the dotcom crash, when its forward PE topped 120.
* Fed Makeup
The composition – and independence – of the Federal Reserve in President Donald Trump’s second term continues to dominate Fed watchers’ thinking, with the focus right now centered on Governor Lisa Cook and board nominee Stephen Miran.
A federal judge has temporarily blocked Trump from firing Cook while Miran, currently a White House economic adviser, has cleared a U.S. Senate hurdle. Meanwhile, Trump on Wednesday lambasted Fed Chair Jerome Powell, calling him “a total disaster, who doesn’t have a clue” and insisting that the Fed slash interest rates.
* Geopolitics
Oil prices spiked on Wednesday after an Israeli attack in Qatar’s capital Doha, and the Polish zloty had its worst day in over a month after Poland shot down suspected Russian drones in its airspace, the first time a member of NATO is known to have fired shots during Russia’s war in Ukraine.
The moves weren’t too dramatic, but were a reminder to investors of the political risk in pockets around the world that can quickly spill over into asset prices and market volatility.
‘Real’ rate dip threatens to pull down dollar
The dollar has been beaten down this year as investors have priced in a resumption of the Federal Reserve’s rate-cutting cycle. But even if lower nominal rates are already reflected in the greenback’s price, lower ‘real’ rates may not be.
The greenback has gotten a bit of respite recently after recording its worst start to any calendar year since the era of free-floating exchange rates was introduced over 50 years ago. But it will face a renewed headwind if its real interest rate support evaporates, which currently seems likely.
If the Fed pulls the rate cut trigger next week, as expected, it will be doing so with inflation around 3% – a percentage point above the central bank’s 2% target. Further easing amid sticky prices means the gap between the U.S.’s inflation-adjusted or ‘real’ interest rate and those of its developed market peers should narrow – bad news for the dollar.
‘REAL’ PAIN
The difference in inflation-adjusted or ‘real’ interest rates and yields is often thought to play the biggest role in determining the relative returns and purchasing power of currencies.
Depending on what cut of annual inflation you use, the ‘real’ federal funds rate right now is somewhere in the 1.3-1.8% range. That’s much higher than equivalent rates in the euro zone, Britain and most notably Japan, where the real policy rate is deeply negative.
You can argue this hasn’t prevented the dollar’s eye-popping decline so far this year. But maybe that ‘real’ advantage at the short end helped avert an even steeper slide. What’s going to happen if that support evaporates?
It already has further out the curve. The dollar’s 10% slide this year is thanks in no small part to the collapse in its positive real yield differentials in the five- and 10-year space, for example. These spreads are currently the narrowest since early 2022, but can shrink further.
SIXTH TIME’S THE CHARM?
Rates futures traders expect the Fed to cut rates by some 150 basis points by the end of next year, the most in the developed world but only really playing catch-up with most of these countries.
On the other side of the ‘real’ rate equation is inflation, which remains sticky and above target across the developed world, but particularly in the United States – and that’s before the tariff price shock truly hits.
Economists at JP Morgan on Tuesday warned that, barring recession, 2026 will likely be the sixth year in a row expectations of inflation returning to target will not be met.
They note that policymakers’ inflation forecasting record since 2021 has been “less than exemplary,” to put it charitably. They reckon central banks have, on average, underestimated core inflation over the period by about one percentage point and overshot their targets by 1.5 percentage points.
The Bank of England has the worst record, but given the Fed’s global prominence, its poor marks are what really stand out. The U.S. central bank’s inflation forecasts have missed by an average of 1.3 percentage point over this period, and it has overshot its target by roughly 2 percentage points.
Of course, maybe the sixth time will be the charm, and inflation will ease in line with Fed forecasts next year. The soft U.S. labor market appears quite a bit mushier following Tuesday’s announcement of a record downward revision of payrolls growth. And if unemployment rises, consumer demand, economic activity, and price pressures will surely cool.
But for now, inflation concerns still appear to be simmering. U.S. consumer inflation expectations are, by some measures, closer to 5% than the Fed’s 2% goal, financial conditions are the loosest in years, and monetary and fiscal stimulus look to be coming down the pike.
Put everything together, and you have the recipe for lower U.S. real rates and more dollar pain.
What could move markets tomorrow?
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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.
(By Jamie McGeever; Editing by Nia Williams)
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