08:00 AM EDT, 08/14/2024 (MT Newswires) -- Bond yields and the US dollar (USD) retained their lower bias early Wednesday after below-forecast US producer price index (PPI) data on Tuesday was followed by the surprise 25bps rate cut in New Zealand and below-forecast United Kingdom services inflation in July, said Societe Generale.

The PPI data reinforced optimism over disinflation and a first-rate cut by the US Federal Reserve in September, but the consumer price index (CPI) on Wednesday is the bigger test, wrote the bank in a note to clients. A total of four cuts over three meetings still appears excessive relative to the Fed's base case for one.

Wednesday's CPI print is unlikely to decide whether the first cut is the deepest but could provide cover for the Fed to reassess the path at Jackson Hole next week, stated SocGen. Assuming that inflation has been defeated, retail sales on Thursday will tell investors more about private consumption and the pace of gross domestic product (GDP) growth in Q3.

The data may also decide if short covering in US Treasuries (UST) has further to run and 10-year yields can have a second go at 3.80%, pointed out the bank. The S&P is seemingly off to the races after erasing the Aug. 2 gap and closing above 5,410 on Wednesday.

In foreign exchange (FX), the slump in the New Zealand dollar (NZD) stands out in G10 but EUR/USD is attempting another breakout, navigating between 1.0980 and 1.1010.

SocGen observed that CPI can be very different from PPI. No seasoned observer has forgotten the price action of August last year when CPI for core services excluding housing surprised to the upside (+0.34% m/m) and caused yields to back up by 30bps across the curve.

This time is meant to be different, with the rebalancing between supply and demand in the economy having made further progress. The decrease in PPI services by 0.2% in July raised optimism for an equally friendly outcome Wednesday for core services CPI. Soft PPI components outside of financial services also bolstered optimism for benign PCE inflation on Aug. 30.

The 25bps rate cut to 5.25% and discussion of 50bps in New Zealand overnight Tuesday is instructive of how the debate on inflation has shifted and the implications it entails for the interest rate outlook, according to the bank. In the statement, the Reserve Bank of New Zealand (RBNZ) said inflation is returning to within the 1%-3% target band.

RBNZ says "inflation expectations, firms' pricing behaviour, headline inflation, and a variety of core inflation measures are moving consistent with low and stable inflation." It forecasts average OCR falling to 4.92% by this December and to 3.85% by December 2025. That's between five and six rate cuts by the end of next year.

AUD/NZD back up above 1.10 and based on RBA/RBNZ divergence further appreciation in the cross towards the highs of July around 1.1150 is possible.

In the UK, optimism of two additional rate cuts this year received a lift after services inflation slowed in July to 5.2%, below the Bank of England (BoE) forecast of 5.6%, added SocGen. The data vindicates the first rate cut two weeks ago and lifts the market implied probability of a second cut in September close to 50%.

The re-acceleration in headline CPI by 0.2ppt to 2.2% puts a dent in real wages. Data Tuesday showed nominal pay excluding bonuses slowed by 0.3ppt to 5.4%. The CPI data the wind out of the sails of sterling (GBP) and nudges EUR/GBP back over 0.8550. Gilts are flying relative to Bunds with yields down 3bps-5bps across the curve and 2s/10s and 5s/30s bull steepening in the process.

Above-forecast CPIF excluding energy inflation in Sweden shouldn't stop the central bank (Riksbank) from lowering interest rates next week, noted SocGen.

Weak China credit data for July published on Tuesday dimmed hopes for a spurt in economic activity, so those investors looking for the CNY to carry on in a positive vein must rely on soft US CPI instead of stronger China activity data on Wednesday. New household loans totaled RMB200 billion, similar to last year's levels.

Medium-to-long-term corporate loans (a better gauge of underlying demand) declined by about RMB260 billion y/y to RMB130 billion. The bank blames disappointing demand in part on the regulatory crackdown.

China's central bank (PBoC) is forecast to leave the one-year medium-term lending facility (MLF) at 2.30% after a 20bps cut last month, but more easing is likely to follow soon to cushion the slowing economy.

In Latin America, Brazil's real (BRL) will resume trading below 5.50 after an eighth successive day of gains and close below the 50dma. The 7.5% rebound from the low of 5.86/USD a week ago outpaces the previous two episodes when the real was bruised In April and late June/early July. Implied volatility remains elevated however and is deterring carry interest.

In a presentation at the lower house of Congress, central bank (BCB) President Roberto Campos Neto said Brazil's unanchored inflation estimates are a concern.