The mood music around trade negotiations has improved, but last week’s ‘reflation trade’ – led by a rally in financials and energy stocks – is being driven by a strong domestic economy in the US. Initial jobless claims tumbled last week to just 204k. Wages are showing signs of turning up. The Treasury market is right to price in higher inflation expectations, even before this morning’s spike in oil prices.
Indeed, if last week’s claims report becomes the new ‘norm’, inflation expectations will rise quickly. The core CPI has turned up, although, it should be stressed, this is not broad-based reflation. The sudden jump in services inflation is entirely due to a correction in medical care services. The durables CPI is edging up.
However, on both counts, the core consumption deflator has diverged in recent months, and may show a smaller acceleration when the August report is published.
The slower rise in the core consumption deflator will give the Fed the breathing space to cut rates this week, even though, on many counts, there is little justification for cheaper money. Credit conditions have palpably loosened this year. The Fed may decide to cut this week, but then shift to a more neutral setting going forward, despite President Trump’s verbal onslaught.
