The “strange week” filled with mixed signals in the financial markets begins to end

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It’s been a stunning week across various asset classes – one that has left investors and traders alike to different conclusions about what to expect after data releases showed US inflation slowing more than expected.

Some describe the stock market as “euphoric” about the possibility that the worst of inflation may be behind. The major indices have continued to rebound vigorously from their mid-June lows. Oil futures remained on track for a weekly rise as fears of a sharp global slowdown eased in parts of the financial market. Meanwhile, the bond market has issued flashing warnings of a possible economic slowdown and more than half of respondents to a BofA Securities FX sentiment and rates survey conclude that inflation will always require persistently tight policy or more rate hikes.

This time of year is filled with summer holidays and is usually accompanied by a period of trading inactivity, which traditionally results in what BMO Capital Markets strategists call “listless price action and limited volumes”. But this cycle is anything but typical, they said.

“It has been a strange week for the financial markets, filled with mixed signals,” Marios Hadjikyriacos, senior investment analyst at XM, a Cyprus-based multi-asset brokerage, wrote in a note.

Rather than definitively settling the debate on the path of inflation, Wednesday’s consumer price index report, which showed the headline annual rate falling to 8.5% in July, and data on Thursday’s producer prices, which showed the first negative monthly result since April 2020, ushered in a deeper dialogue from policymakers on the continued need for higher interest rates.

Richmond Fed President Tom Barkin said in an interview with CNBC on Friday that while the inflation data was “welcome,” the Fed should raise its benchmark interest rate target further until that the data show continued progress. His remarks came as the Cboe Volatility Index, otherwise known as VIX VIX,
-4.75%,
or the stock market’s “fear gauge” fell back below 20 for the first time since April.

Read: Does the stock market’s favorite ‘fear gauge’ signal more pain ahead for investors?

There are “a lot of skeptics who will say August is a euphoric overshoot” for stocks, “giving the market an excuse to trade bad news is good and good news is also good,” said Ben Emons, Managing Director of Global Macro Strategy. at Medley Global Advisors in New York. “For those who think the market is a little too euphoric about peak inflation, collapsing volatility presents attractive levels to buy puts.”

Complicating the inflation outlook for some is that the argument can be made that not all price pressures are easing, despite growing signs of a turning point in inflation: intact,” according to Simon MacAdam, senior global economist for Capital Economics.

Gold – which has generally underperformed as an inflation hedge this year, although it should benefit from its safe-haven status – is poised to hold onto a modest weekly gain, despite a post-war pullback. CPI Thursday and Friday. In other post-CPI moves, the ICE US Dollar Index DXY fell on Wednesday and Thursday even as long-term Treasury yields soared – when they would normally move in tandem.

Falling consumer and producer prices “raised hopes that the worst days of inflation were behind us and that the Fed would not need to be so aggressive in raising rates, dealing a blow to the US dollar,” XM’s Hadjikyriacos said. “But the bond market refuses to buy into that narrative,” he said, adding that long-term yields are set to end for the week anyway, believing that a “timid Fed today today could mean higher inflation down the road.”

In other words, Hadjikyriacos said, “forex [foreign-exchange] traders are focused on the near-term prospect of the Fed easing the brakes, while bond traders are taking a more holistic view that the battle against inflation is not nearly over.

On Friday afternoon, stocks were significantly higher, with Dow Industrials DJIA,
+0.84%
up 0.8%, the S&P 500 SPX,
+1.13%
gaining 1% and the Nasdaq Composite COMP,
+1.47%
up 1.3%. Treasury yields were mixed, holding the gap between 2-TMUBMUSD02Y,
3.240%
and 10-year rate TMUBMUSD10Y,
2.853%
deeply reversed to minus 38 basis points in a worrying sign of the outlook.

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