The narrative on the US economy will shift depending on how inflation data pans out this week. We think market participants are beginning to take notice that US labour market data may be weakening. Accordingly, this puts either soft-landing or stagflation into focus. The former would become the dominant theme if inflation cools. Under this scenario, the Fed would face a simpler choice of calibrating interest rates lower, allowing for a steeper curve. By contrast, sticky inflation would result in a conflict in the Fed’s dual mandate and the market would shift to a stagflation playbook keep curves inverted for longer.
Consensus is looking for a 0.4% MoM sa (3.4% YoY) increase in CPI, roughly in line with pricing of the inflation swap fixing for April (3.42%). After three months of upside surprises in price pressures and where rates are trading currently (1.6 cuts for the year), we think that US yields may be more reactive to a downside miss in CPI readings. If CPI surprises on the upside, we think that spikes in 2Y and 5Y rates may be more interesting to receive into given that the hurdle for hikes remain high. Moreover, worries that labour market may be softening is likely to surface.
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