US rates markets steepened on Thursday after a weaker-than-expected headline PCE Price Index prompted an initial rally, although stronger personal income and spending added complexity for the USD. The Lisa Cook decision was not issued by SCOTUS, and the next opinions are scheduled for Monday. With fresh catalysts limited, attention turns to Friday’s U Mich confidence release and remarks from Federal Reserve speakers, while geopolitical developments in the Middle East remain a near-term watchpoint.
Core PCE rose 0.32% m/m in May and ran at 3.4% y/y, while headline PCE printed 0.45% m/m and 4.1% y/y, with energy contributing to the firmer headline. TD’s core PCE forecast was 0.36% versus 0.3% for consensus. Market-based core PCE was 0.24% m/m, with strength partly linked to financial services. Fed commentary included Goolsbee pushing back on forward guidance, and Williams indicating no apparent appetite for hikes while implying cuts may be pushed into 2027-2028; Kashkari is due to speak at the Aspen Ideas panel.
Choppy Market Conditions and Policy Outlook
We are seeing the US rates market trade without clear direction as investors process the latest economic reports. The recent Personal Consumption Expenditures (PCE) data showed weaker headline inflation, but this was offset by surprisingly strong personal income and spending figures. This mixed picture is creating choppy conditions and prevents a strong directional bet on the US Dollar.
We believe the latest core PCE inflation reading, which printed at 2.5% year-over-year for May, confirms that price pressures are not running rampant. However, with this figure still well above the Federal Reserve’s 2% target, it complicates the path for interest rate policy. The market is now pricing in a prolonged pause from the Fed, with the federal funds rate holding steady around 3.75%.
Recent comments from Fed officials suggest they are in no rush to cut rates and are pushing back against market expectations for easing. This outlook, combined with persistent inflation in the services sector, makes us nervous about taking on too much long-term interest rate risk. History shows that in similar periods of uncertainty, such as the sideways markets of 2015-2016, volatility can spike unexpectedly.
Market Strategies Amid Uncertainty
The latest University of Michigan consumer confidence survey adds to the cloudy outlook, falling to a seven-month low of 65.6. This weak sentiment clashes with the strong spending data, suggesting we should consider strategies that benefit from a sharp move in either direction, such as long straddles on key currency pairs like EUR/USD. Without a clear catalyst, the market is likely to remain stuck in a range.
Given this backdrop, we are advising a cautious stance, focusing on short-term opportunities. The lack of immediate drivers and ongoing geopolitical tensions in the Middle East suggest implied volatility may be underpriced. Selling short-dated options to collect premium could be a viable strategy as we wait for a clearer signal to emerge.
