Weak nonfarm payrolls data cools rate hike expectations—could this fuel another rally in US stocks?

高腾国际

joined discussion ·

Gaozhan Weekly Interest Rate Analysis | Cooling CPI Meets Surging Oil Prices! Divergence Again?

Issue #202618

Last issue’s column unpacked the rationale behind the renewed rate hike expectations—AI inflation specter, surging oil prices, and hawkish tone in meeting minutesThis triple convergence has pushed the probability of a July rate hike to 33.7%.

Last week, June CPI came in broadly below expectations, causing the rate hike probability to plunge to 14.4%; however, $Brent Last Day Financial Futures (DEC6) (BZmain.US)$ surged 15.91% in a single day, $Gold Futures (DEC6) (GCmain.US)$ fell by 2.56% instead.

‘Dovish data + surging commodities,’stems from three colliding factors: structural cooling in CPI, Middle East geopolitical supply shocks, and Waller’s hawkish remarks during his congressional hearing.

This article will unpack the market divergence behind the reversal in rate hike expectations from three angles: CPI component analysis, oil price transmission channels, and pricing discrepancies in the yield curve.

▌FedWatch Data Quick View

CME FedWatch (as of July 19) shows there are still 10 days until the FOMC meeting on July 28–29.

The probability of maintaining rates at 3.50%–3.75% stands at 85.6%, a significant jump from 65.8% a week ago.

The probability of a rate hike to 3.75%–4.00% is 14.4%, down from 34.2% a week ago and 38.5% a month ago.

Rate hike expectations have cooled significantly, driven by June CPI coming in broadly below expectations.

▌Cooling CPI Reverses Rate Hike Bets

Last week’s macro narrative was clear: June CPI data reversed the prior period’s rising rate hike expectations.

Declining retail fuel prices, zero month-over-month growth in core services, and weak second-round inflation effects collectively weakened the hawks’ arguments.

$CITIC SEC (06030.HK)$ It noted that U.S. headline CPI year-over-year has already passed its peak in this cycle and still expects the Fed to remain on hold for the rest of this year.

▌Three Key Drivers Behind the Reversal in Rate Hike Expectations

Structural Cooling in CPI

June CPI came in broadly below expectations, with core services posting zero month-over-month growth and second-round inflation effects remaining muted (source: BLS). Headline CPI year-over-year has confirmed it has passed its peak in this cycle and is expected to moderately decline in Q3.

Waller’s Congressional testimony struck a hawkish tone

as Federal Reserve ChairKevin WarshDownplay the impact of CPI, emphasizing‘Disagree with cherry-picking only favorable data’. Zero tolerance for persistently high inflation; reiterates commitment to fighting inflation.

Soaring oil prices pose a hedging risk

$Brent Last Day Financial Futures (DEC6) (BZmain.US)$ jumped 15.91% in a single day to $88.09, $Crude Oil Futures (SEP6) (CLmain.US)$ rose 14.35% to $81.77. Geopolitical supply shocks have directly pushed up short-term inflation expectations, offsetting the cooling seen in CPI.

▌ Yield Curve: Divergent Steepening

Last week, the yield curve exhibited divergent steepening.

$U.S. 1-Year Treasury Bills Yield (US12M.BD)$ fell 1.50% to 3.935%, $U.S. 3-Year Treasury Notes Yield (US3Y.BD)$ declined 0.53% to 4.219%, $U.S. 5-Year Treasury Notes Yield (US5Y.BD)$ fell 0.44% to 4.286%. $U.S. 10-Year Treasury Notes Yield (US10Y.BD)$ edged down 0.13% to 4.554%, $U.S. 30-Year Treasury Bonds Yield (US30Y.BD)$ rose instead by 0.24% to 5.072%.

Short-end rates reflect cooling rate hike expectations, while long-end rates price in inflation risks driven by rising oil prices—the widening term spread indicates a divergence in market pricing between near-term policy and medium-term inflation outlooks.

▌ Fed Watch: Waller’s Congressional Hearings Over Two Days

Fed Chair Kevin Waller testified before the Senate Banking Committee on July 14–15. He downplayed the impact of CPI data, emphasized the Fed’s resolve to combat inflation, and noted that AI is affecting demand faster than supply.

The Beige Book reported modest growth in economic activity across 11 of the 12 districts, with multiple districts highlighting high uncertainty around fuel cost outlooks.

▌ Internal Divergence: Hawks Hold Firm, Doves Speak Out

Hawks:

President of the Kansas City FedSchmidWarned that inflation could accelerate further; President of the Cleveland FedHammackSaid persistently high inflation is a greater concern.

Dovish:

President of the New York FedJohn WilliamsExpected rates to eventually decline as inflation eases, forecasting year-end inflation at 3.25%; Fed GovernorWallerSaid that a decline in core inflation would support holding rates steady.

Centrist:

Federal Reserve Vice ChairJeffersonstated that the labor market remains stable and that policy should be reassessed if inflation does not cool; Federal Reserve GovernorCooksaid there is reason to believe inflation will continue to ease.

▌ Key Data: June CPI and Beige Book

June CPI came in broadly below expectations (source: BLS). Retail gasoline prices declined, and core services posted zero month-over-month growth.

The Beige Book indicated modest expansion in economic activity from late May through June, with employment generally rising, though uncertainty around fuel cost outlook remains elevated.

This data combination weakens the case for further rate hikes, but upside risks to oil prices constrain room for rate cuts.

▌ Historical Perspective: The Policy Dilemma of Geopolitical Oil Price Shocks

During the Russia-Ukraine conflict in 2022, surging oil prices temporarily delayed the Fed’s pivot toward rate cuts. Current Middle East risks echo similar supply shock dynamics, but with CPI already cooling ahead of time, the policy path has become more uncertain.

▌ Scenario Analysis

Scenario 1 (oil prices retreat + inflation continues to cool): Rate hike expectations further decline, short-end rates fall faster, the yield curve steepens bullishly, and the dollar comes under pressure.

Scenario 2 (oil prices remain elevated + inflation proves persistent): Rate hike expectations reignite, long-end rates rise faster, the yield curve steepens bearishly, and the dollar strengthens.

Currently leaning toward Scenario 1, but Middle East tensions could become a turning point.

▌ Other major central bank activities

People’s Bank of China: Last week, it conducted a total of RMB 1.74 trillion in 7-day reverse repos and RMB 1.4 trillion in 6-month outright reverse repos, both at an interest rate of 1.40%. Total social financing increased by RMB 20.84 trillion in H1, RMB 2.02 trillion less than the same period last year.

Bank of Japan: Senior officials warned that delaying adjustments to stimulus measures could turn risks into reality, as upside inflation risks are currently high.

European Central Bank: Governing Council member Panetta stated inflation is around 3% and is expected to remain above that level until early 2027; Kocher noted no signs of second-round inflation effects. Bank of England: Traders have fully priced in a 25-basis-point rate hike by September.

▌ Market Reaction: Commodities surge while bond markets diverge

Last week, Brent crude surged 15.91% to $88.09, and WTI rose 14.35% to $81.77, reflecting pricing in of Middle East supply risks.

Short-end U.S. Treasury yields declined, pricing in diminished rate hike expectations; conversely, the 30-year yield rose 0.24% to 5.072%, pricing in inflation risks driven by higher oil prices.

$USD (USDindex.FX)$ The dollar index dipped slightly by 0.21% to 100.754, while gold fell 2.56% to $4,023.0, as safe-haven demand gave way to real-rate pressures from rising oil prices.

Commodity prices are surging alongside a sell-off in short-end bonds, reflecting divergent market pricing of inflation trajectories.

Summary and Outlook

Last week's key signal was the reversal of rate hike expectations and the pricing of yield curve divergence. Cooling CPI data weakened the case for near-term hikes, but oil price shocks limited room for rate cuts.

Investors should closely monitor the FOMC meeting on July 30 and subsequent developments in the Middle East—these two pivotal events will test the policy follow-through of the recent reversal in rate hike expectations.

$Hang Seng Index (800000.HK)$ $Hang Seng TECH Index (800700.HK)$ $Nasdaq Composite Index (.IXIC.US)$ $Dow Jones Industrial Average (.DJI.US)$ $S&P 500 Index (.SPX.US)$

231K Views