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Today's economic developments and market movements.

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Key themes:
 Softer-than-expected inflation data in the US and UK prompted a relief rally in rates and equity markets overnight as signs of further disinflation progress buoyed expectations for rate cuts.

There is now around 40 basis points of rate cuts priced into the US rates curve for 2025 compared to around 30 basis points on Tuesday’s close. In the UK there’s now 55 basis points of cuts priced in for 2025, up over 25 basis points on Tuesday’s close.

The US dollar pulled back on the lower rates structure and is now back trading around pre-payrolls levels. The Japanese Yen and the Aussie dollar were the biggest beneficiaries of the weaker US dollar.

Israel and Hamas agreed to a 6-week ceasefire beginning Sunday. The deal includes the release of dozens of hostages and the withdrawal of Israeli troop from populated areas of Gaza.

Share markets: Equity markets took advantage of lower global yields following encouraging inflation data. The S&P 500 posted its largest daily gain since November, taking valuations back above where they were ahead of last weeks US payrolls report and swinging year-to-date losses into gains. 

European equities also hit year-to-date highs, though the FTSE 100 in the UK was the laggard failing to retrace its post-payrolls slide despite a 1.2% daily gain.

Asian equities were broadly softer yesterday. The ASX 200 shed 0.2%, while stocks in Japan and China were also modestly lower. ASX Futures are up 1.3% on yesterday’s close, pointing to a strong open this morning.

Interest rates: Rates markets finally caught a break on softer inflation data with yield structures 10-15 basis points lower across the US and UK. Europe caught some of the bid momentum with yields down around 5-10 basis points in most tenors.

10-year yields led the rally, with 2-10-year curves flattening and 10-30-year curves steepening modestly in both the US and UK. 

There is now around 40 basis points of rate cuts priced into the US rates curve for 2025 compared to around 30 basis points on Tuesday’s close. In the UK there’s now 55 basis points of cuts priced in by the end of the year, up over 25 basis points on Tuesday’s close.

Aussie yields were little-changed yesteday but overnight futures rallied 9 and 10 basis points respectively in the 3-and-10-year tenors. Expectations for the quantum of RBA rate cuts  in 2025 have also increased by about 10 basis points to around 70 bais points of cuts.

Foreign exchange: The US dollar pulled back on the lower rates structure and is now back trading around pre-payrolls levels at 109.06 after briefly touching a low of 108.60. 

The Japanese Yen and the Aussie dollar were the biggest beneficiaries of the weaker US dollar, though most G-10 currencies caught some reprieve against the Greenback. The Aussie dollar is back up around 0.6229, fully retracing the sell-off over the start of this week. Labour force data today is one of two key data inputs (the second being December quarter inflation data later this month) which will determine the outcome of the RBA’s February meeting. A softer than expected outcome will likely see the Aussie dollar re-test the 62 cent level, while a stronger outcome is likely to extend the overnight move.

The Japanese Yen briefly navigated year-to-date highs, supported by the softer US dollar leg and firming expectations for a rate hike from the Bank of Japan (BoJ) next week.

The Euro underperformed despite the US dollar sell-off, edging slightly lower. The Euro’s broad down-trend since November last year remains in-tact with few clear near-term catalysts to shake the funk. The Euro’s failure to capitalise on the weaker US dollar overnight does not bode well for the Euro’s near-term outlook.

Commodities: Crude prices leapt higher despite news of a ceasefire between Israel and Hamas which should cool tensions in the Middle-East, at least temporarily. Fresh sanctions on Russia began to affect crude flows and the US reported another drop in inventory levels, spurring gains.

West Texas Intermediate (WTI) futures are up 3.9% at US$80.53 per barrel, the highest level since July last year.

US crude inventories fell by 1.96 million barrels last week, the eighth straight decline, Energy Information Administration (EIA)data showed. The IEA said the latest US sanctions have the potential to disrupt 22% of Russia’s energy exports.

Metals were generally higher helped by the softer US inflation. Copper is up 0.% at $9,104 while aluminium jumped by 1.7% to $2,604, closing above $2,600 for the first time in a month. The rise was helped by news the Europe was said to be considering curbs on Russian aluminium and phasing out LNG imports as part of a new sanctions package. The EU aims to adopt the new package next month, marking three years since Russia invaded Ukraine. 

Iron ore probed further above US$100 helped by signs of restocking and stronger Chinese steel production data from the end of December and beginning of January. Given the early Lunar New Year holiday this year, restocking has been more present early January, adding to the improved sentiment. 

Australia: There were no major economic data releases yesterday.

United Kingdom: After surging 0.8 percentage points in the two months to November to reach 2.6%, headline inflation eased to 2.5% in December, in line with the Bank of England’s (BoE) forecast, and below consensus expectations. 

Services inflation decreased sharply to an annual rate of 4.4%, the lowest level since March 2022, a move that will be welcomed by the policy makers at the BoE. However, it is worth highlighting that a sharp drop in the volatile component of air fares contributed to this decline. Core goods inflation was up to 1.2% over 2024, leaving annual core inflation at 3.2%, down from 3.5% in November.

United States: The consumer price index (CPI) accelerated in December, rising 0.4% in the month, up from 0.3% in November. However, close to a half of the increase was accounted for by the energy component, which was driven by a 4.4% monthly increase in gasoline prices.

The more closely watched core measure was softer and well below expectations, partly soothing some concerns of sticky inflation. Core CPI rose 0.2% in the month, the softest monthly reading since July. This saw annual core inflation slow to 3.2% from 3.3%, where it was anchored for the previous three months. 

Most of the monthly slowdown in core inflation was driven by core goods prices, while core services inflation was little changed on November’s pace, though this was still a solid improvement in the pace of core services inflation compared to the remainder of H2 2024. Crucially, the supercore inflation measure edged down to 0.2% from 0.3% in November.

The Fed will be pleased with the decline in core inflation, and it should give them greater confidence that disinflation remains in progress, supporting further policy normalization. However, the case to slow the pace of rate cuts, as foreshadowed by several Fed officials, remains a strong one. 

Richmond Fed boss, Tom Barkin, said that the CPI release “continues the story we’ve been on, which is that inflation is coming down toward target”. Meanwhile, John Williams, president of the New York Fed, said that “the process of disinflation remains in train”.

The Beige Book, a survey of information gathered by the Fed in its twelve districts,  hinted at a somewhat firmer pace of economic growth in the US. The description of growth in activity improved from ‘slightly’ to ‘slightly to moderately’. The survey mentioned firmer consumer spending and ‘strong holiday sales that exceeded expectations’ as potential drivers. The characterisation of the labour market conditions was not materially different from last month’s survey, but wage growth was now described as ‘moderate’, up from ‘modest’ used previously. However, the latter word was used to describe price inflation. Looking ahead the Fed’s “contacts expected prices to continue to rise in 2025, with some noting the potential for higher tariffs to contribute to price increases”.

The Empire Manufacturing survey reported a decline in general business conditions at the start of this year. The headline index, which has been particularly volatile lately, was down from 2.1 to -12.6, among the lowest readings over the last twelve months. But firms were more optimistic about the outlook ahead, with business expectations index rising to 36.7, the highest level since late 2021.

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