European assets surged on Wednesday following a lower-than-expected inflation report in the United States, brightening the outlook for potential Federal Reserve interest rate cuts this year.
ADVERTISEMENTIn May, the US Consumer Price Index (CPI) rose by 3.3% year-over-year, according to the Bureau of Labor Statistics. This figure is lower than both the previous and expected 3.4%. The monthly variation in the overall consumer basket was flat, falling short of the predicted 0.1% and sharply decelerating from April’s 0.3% pace.
US inflation falls more than predicted
A key factor in May’s disinflation was a 2% reduction in the energy index, with fuel prices dropping 3.6% month-over-month. Excluding food and energy items, core inflation also cooled from 3.6% to 3.4%, easing more than the expected 3.5%. On a monthly basis, the underlying inflation measure advanced at a 0.2% pace, lower than the predicted 0.3%.
Market reactions ahead of today’s Fed meeting
The cooler-than-expected inflation report reignited market expectations for interest rate cuts by the Federal Reserve. Before the release, traders had assigned a 54% chance of a September rate cut, which increased to over 70% by 2:45 p.m. CET.
This shift indicates that the market is now more inclined to bet on the start of the Fed rate cut cycle by the end of the summer.
Overall, markets are pricing in 54 basis points of cuts—equivalent to two 25-basis-point rate reductions—by year-end.
US Treasury yields tumbled by more than 10 basis points following the inflation report, easing pressure on the European bond market.
European bond yields, which had seen sharp increases following the recent parliamentary election results, also softened.
Bund yields dropped by 6 basis points, while yields on 10-year French OATs, Spanish Bonos, and Italian BTPs fell by 7, 9, and 13 basis points respectively on Wednesday.
European equities turned green after three consecutive sessions of losses. The broader Euro Stoxx 50 rose by 1%, reversing Tuesday’s decline. The German DAX and the Italian FTSE MIB increased by 1.1% and 1.4% respectively. The French CAC 40 index also rose by 0.7%, although it underperformed its peers.
The U.S. dollar weakened sharply against major currencies, with the euro-dollar exchange rate rising by 0.8% to above 1.0820, marking its strongest performance since late December 2023.
Markets await pivotal Federal Reserve meeting
Attention now shifts to the Federal Open Market Committee (FOMC) meeting at 8:00 p.m. CET.
The Federal Reserve is widely expected to maintain the federal funds rate between 5.25% and 5.50% for the seventh consecutive meeting, yet the major attention will be on the new staff economic projections.
Investors will closely monitor whether Fed policymakers adjust the median rate cut projections, which in March indicated three rate cuts in 2024, followed by three more in both 2025 and 2026.
Any downward revision to the expected rate cuts could temper market excitement following the lower-than-expected inflation report. Conversely, if the Fed confirms these forecasts, it would signal confidence that inflation is gradually moving towards the 2% target.
The Fed will also unveil projections on inflation and economic growth. Fed Chair Jerome Powell is set to hold a press conference at 8:30 p.m. CET to discuss these developments. Investors will be particularly attentive to Powell’s remarks for any hints about the future trajectory of interest rates and the overall economic outlook.
