The market's cautious reaction to Tuesday's stronger-than-expected US PPI print has been validated in the short term. In April, the US consumer price index defied expectations, dropping 10 basis points below the consensus of 0.4%, resulting in annual headline and core inflation rates falling to 3.4% and 3.6% respectively. This downward surprise has further fuelled the ongoing movement of capital into risk-sensitive assets such as equities, the euro, and the pound. Throughout the week, US Treasury yields have decreased across the curve, while the US dollar is poised for a 1% weekly decline.
Yet, this celebratory moment for investors signifies a sense of relief as US inflation appears to be receding after a series of unsettling upside surprises in Q1. However, the report itself doesn't necessarily indicate softness, as service inflation, including and excluding the lagging shelter component, remains elevated at 5.2% and 4.9% respectively. Both annualized and annual growth rates are distant from suggesting rate cuts from the Federal Reserve (Fed). Nevertheless, following the data release, traders have solidified expectations for Fed rate cuts in both September and December, with pricing indicating a year-end policy rate of 4.75%-5%, down from the current range of 5.25%-5.5%.
Shaping these expectations further will depend on upcoming macroeconomic data, which is anticipated to weaken. There's a potential for a downside surprise to GDP expectations for Q2. Last week, we noted the overly optimistic 4.1% Atlanta Fed GDP Nowcast for the second quarter, considering softer leading indicators. Since then, the Fed's estimate has decreased to 3.7%, attributed to yesterday's disappointing retail sales figures. Spending remained stagnant in April after robust gains in the previous month. While not alarming by itself, it suggests a weaker start to Q2.
Sterling has surged to its highest level in five weeks, reaching $1.27 against the US dollar. This breakout marks a departure from a three-month descending trend channel and positions the pound for its second-largest weekly gain (1.3%) of 2024. The demand for pro-cyclical currencies, such as the pound, has surged due to increased speculation of global interest rate cuts. This sentiment has led to a rise in global bond prices and a subsequent drop in yields, with both the US and UK 10-year yields reaching fresh one-month lows. Meanwhile, the S&P 500 has achieved its 23rd record high of 2024, reflecting elevated global risk appetite.
GBP/USD has surpassed a significant technical retracement level by recovering more than 61.8% of its decline from its 2024 peak of $1.29 to its low of $1.23. This upward movement is primarily driven by a weakening US dollar and a positive global economic outlook. Additionally, improvements in the UK economic forecast have bolstered support for UK assets. From a technical standpoint, the currency pair has regained key daily and weekly moving averages, signaling a bullish trend. After closing above its 200-day moving average on Monday, it has crossed its 50-day and 100-day moving averages in subsequent sessions. Bullish attention is now turning towards the 200-week moving average at $1.2860, where it previously peaked in March.
While the rapid increase in value has not pushed the daily Relative Strength Index into overbought territory, GBP/USD is currently trading above its upper Bollinger Band, suggesting a potential pullback in the near term. Investors are now awaiting further US economic data, but the focus is likely to shift to UK inflation data next week for insights into the Bank of England's policy direction. If UK CPI figures come in lower than expected, the likelihood of a rate cut by the BoE in June may increase, potentially reversing some of sterling's recent gains.
