Mixed sentiment in markets as inflation outpaces expectations

January CPI data

Annual CPI rose to 3.10% in January, which represented a decline from the December reading of 3.40%, but also outpaced the market expectation of 3.00%. In addition, core CPI, which excludes food and energy, came in at 3.90% for the second consecutive month. Markets reacted to the news immediately, with equities falling sharply during the day on Tuesday, and the 10-year Treasury yield rising above 4.30%. Equities rebounded later in the week, but there was further evidence of price increases on Friday, when wholesale prices for January also beat expectations. Overall, this most recent evidence of inflation persistence, particularly regarding core CPI, led investors to dampen their expectations for rate cuts in 2024, with only five cuts now projected. The market is no longer forecasting a rate cut for March or May.

For the time being, the forward curve still follows a sharp downward trend, allowing companies with floating-rate debt to lock in swap rates significantly below current rate fixings, which can lead to a beneficial pick-up on interest expense in the short-term. If market expectations continue to turn more hawkish, in line with recent Fed messaging, we may see a continued flattening of the curve and less favorable swap rates in the future.

USD strengthens on inflation news

The hot inflation reading, in combination with strong jobs data from recent weeks, led the U.S. dollar index to rise sharply on Tuesday, hitting 105 for the first time this year. Some other economic releases also contributed to this spike, as cooling prices in the U.K. and a disappointing GDP reading in Japan helped to bolster the outlook of USD against other currencies. Going forward, the rates outlook in the U.S. and its hawkishness relative to other major countries, will continue to be a big driver of foreign exchange movements.

If your company has predominantly USD inflows and foreign-denominated expenses, the recent strength in USD may have led to material FX gains, as your foreign expenses and liabilities are depreciating in USD terms. This is good news, in the sense that your underlying exposures are seeing gains, but it also means that any hedges of your short, foreign exposures may be experiencing losses. Chatham frequently works with companies to develop hedge reporting that clearly explains exposure and hedge gains/losses — proving that hedges are achieving treasury objectives across various market environments.

The week ahead

This week is fairly quiet on the economic data front, but market participants will review the minutes from the Fed’s February meeting once available on Wednesday. We’ll also have initial jobless claims next Thursday and an important PCE reading later in the month.