Opinions

With more positive news on the labor market last Friday, both Fed officials and market participants will focus on the other side of the dual mandate, inflation. Accelerating job gains and steady unemployment suggest the current policy stance is not restraining the economy. Timely measures of job losses show few signs of stress, while backward looking benchmark data suggest we are unlikely to see a substantial negative revision to NFP later this summer. The unemployment rate has remained stable, and wage growth is decelerating faster than we had expected. Sideways income growth suggests consumer spending should begin to cool later in the summer. But rising confidence in the labor market outlook does not extend to the inflation side of the mandate where pressures are mounting. In US macro data this week we have the all important May CPI, initial jobless claims, May PPI, trade balance etc. We see May core CPI inflation as likely moderating to 0.2% MoM from 0.376% in April as a temporary boost from technical adjustments to rent-related components diminished. Our forecast for headline CPI inflation is 0.454% m-o-m or 4.198% y-o-y. In UST dated supply, we have $58 BN of 3yr UST supply on Tuesday, $39 BN of 10yr UST supply on Wednesday & $22 BN of 30 year UST supply on Thursday. On the Iran conflict, there is no end in sight for the current middle east conflict. With no deal being announced, global crude inventories are nearing very low operational levels. If the Strait of Hormuz does not open by end June, we expect Brent to average 120 in Q3CY26 and 150 in Q4CY26. So to summarise on US economy, we think new inflationary pressures from emerging sources along with anticipated acceleration in May core PCE inflation will keep policymakers vigilant on inflation risks. We maintain our Fed call of no changes in the policy rate through the end of 2027, but the balance of risks seems to be shifting toward the hawkish side. We do not have any strong views on the US yield curve now. But we remain +ve on DXY. Last week close was above 100 which is a +ve sign for DXY. We now expect 100.60 and subsequently 102 as next target levels for DXY. In RoW events, we have ECB meeting on 11th June where we see a neutral 25 bps hike followed by another 25 bps hike in Sep. In Eurozone economic data this week, we have German factory orders & German industrial production.

We see core CPI inflation as likely moderating to 0.2% MoM from 0.376% in April as a temporary boost from technical adjustments to rent-related components diminished. Our forecast for May core PCE inflation is 0.33% m-o-m, up from 0.24% in April, which translates into its y-o-y change rate of 3.4%. Our forecast for headline CPI inflation is 0.45% m-o-m or 4.2% y-o-y. The May CPI report will likely show some spotted strength, reflecting global shortages of semiconductors (e.g., computers) as well as higher jet fuel prices (e.g., airline fares). Core goods inflation looks like a tug of war between waning tariff impact and newly emerging price pressures. We expect super core inflation moderated due to a lack of hotel price inflation and negative residual seasonality. Regular rent and OER inflation in April were boosted by positive payback after last year’s carry-forward imputation in October. Without the impact from this technical adjustment, inflation of rent-related components should return to a gradual downward trend in May. On a whole, the laser focus of current Fed from inflation risks is unlikely to be wavering by May's CPI report. Strong aggregate demand, the AI investment boom, and a series of supply shocks all pose upside risk to the medium-term inflation outlook. We maintain our Fed call of no changes in the policy rate through the end of 2027 although market is currently pricing in 25 bps of hike by end CY26. We do not have any strong views on the US yield curve now. But we remain +ve on DXY. Last week close was above 100 which is a +ve sign for DXY. We now expect 100.60 and subsequently 102 as next target levels for DXY.

The past week saw two important updates that may be consequential for the US economic outlook this year. First, data that feed into current-quarter GDP tracking have continued to show notable resilience in the face of the sharp contraction in oil supply and jump in energy prices. Second, front-month crude oil futures declined over $10/bbl last week on reports of an extended ceasefire that could re-open the Strait of Hormuz. While uncertainties remain, the acute risk phase for the global economy should be over if tankers can begin moving again. In US macro data last week, core PCE came in slightly softer at .24% MoM but YoY remained at 3.3%. Trimmed-mean PCE — which Chair Warsh has highlighted as an alternative gauge of underlying inflation — eased to 2.3% y-o-y, about a full percentage point below core PCE. We believe that trimmed-mean PCE may be understating inflation risks, particularly because it has been slow to capture shifts in goods inflation dynamics and the recent change in the skewness of the inflation distribution. PCE trimmed-mean inflation underestimates the underlying inflation by 48bp on a y-o-y basis. Coming to next week, the economic calendar may move back to the forefront for market participants. The main highlight will be Friday’s May employment report where we expect headline +105k forecast vs. +115k previously. Our forecast would bring the 3m average of NFP growth up to 136k – the strongest since December 2024. In other US macro data next week we have ISM services, ISM manufacturing, JOLTS & initial jobless claims. We do not have dated UST supply next week. Fed speak last week reflected a broad-based shift towards a more hawkish tone on the FOMC, even as most officials continue to expect disinflation in coming months as their base case. Skepticism of labor productivity-led disinflation has been a focus for the FOMC recently. Several officials acknowledged AI’s potential to lift longer run growth but remain unconvinced that productivity gains can reliability ease inflation in the near term. On Iran conflict, no clear resolution in sight yet. US President Donald Trump has demanded changes to a proposed agreement with Iran, triggering a fresh round of negotiations that could delay a final deal by several days. Our own take is a temporary 60-day agreement is likely this week around Wednesday considering both parties are agreeing to not seek war though they do differ on two major topics: SoH and enriched Uranium status. To summarise on US economy, with Iran conflict continuing for more than 2 months now, we expect Fed to remain on hold for next several months till end CY26. Any future inflation developments might be the most-likely catalyst for an eventual resumption of rate cuts or pivot to hikes. In RoW data, we have Eurozone May HICP data on Tuesday which is expected to accelerate to 3.3% from 3% in April. We see two ECB rate hikes in June and Sep this year as a result of higher energy prices.

We expect nonfarm payrolls (NFP) remained elevated at 105k in May against April's no of 115k and current market estimate of 89k. Our forecast would bring the 3m average of NFP growth up to 136k – the strongest since December 2024. Lead indicators have been constructive, continuing to signal an acceleration in employment growth. ADP’s weekly private employment measure remained elevated through April and early May, and continuing jobless claims stabilized close to a multi-year low. 2. The unemployment rate likely remained steady at 4.3%. Measures of hiring and labor demand have shown tentative signs of a rebound, which we expect will lead to a gradual decline in the unemployment rate in H2 2026. 3. Average hourly earnings growth likely rebounded to 0.4% m-o-m. A negative calendar effect and an increase in the average workweek weighed on AHE in April, but underlying wage growth appears elevated, leading us to expect positive payback this month. Service-sector surveys show a pickup in expected wage growth, and the JOLTS quits and hires rates have stabilized in recent quarters. Summary: A report in line with our expectation would likely keep Fed officials focused on inflation risks. We expect the Fed is likely to keep policy on hold in REMCY26, with inflation developments the most-likely catalyst for an eventual resumption of rate cuts or pivot to hikes. From a market perspective, if the report comes in line with our expectations, we expect US bond yields to move higher by 5-6 bps from pre-event levels across the curve. We continue to believe in 2-10 US SOFR steepener as we believe 10yr UST yield has far higher potential to climb up in light of fiscal worries, continued equity traction & sustained selling by foreign investors. Our stop loss on 2-10US SOFR steepener is at 14 level and currently it is at 17. We have a profit target of 40 on this trade. We expect DXY to remain strong post data release.

After Monday’s Memorial Day holiday, market participants will come back to a steady flow of data and Fedspeak, both of which will be evaluated in the context of Governor Waller’s hawkish speech last week. US data remain hawkish, pointing to robust growth and building price pressures. Manufacturing and business capex continue to accelerate. The preliminary S&P Manufacturing PMI rose to a multi-year high. We now expect the Fed to remain on hold for REMCY26 (versus our prior forecast of one cut in Q4CY26). Incoming Fed Chair Kevin Warsh is likely still motivated to cut rates. However, we expect easing political pressure, elevated inflation, and strong cyclical growth to support a prolonged pause. In US macro data this week we have PCE, Q1GDP 2nd estimates, consumer confidence, intial jobless claims. In dated UST supply, we have $69 BN of 2yr UST auction on Tuesday, $28 BN of 2yr FRN auction on Wednesday, $70 BN of 5yr UST on Wednesday again & $44 BN of 7yr UST auction on Thursday. On the Iran conflict, Trump indicated in a post on Saturday that a peace deal was imminent but we have seen so many slips and misses that we wait for the final announcements from both sides. Our own view is that the ceasefire extension of 60 days is very likely. Hajj is wrapping up right now. Many stay 5–7 days afterward for Tawaf, departures, etc., so Saudi soil remains ultra-sensitive into early June. Iran is unlikely to escalate unless attacked in this window for fear of cratering its Pakistan channel. In US we have the world cup Football starting from 11th June till 19th July during which time the US side might like to have lower security threats. In short term we see Brent cooling down to 90-100 range if the ceasefire does get announced as Trump indicated. We will be releasing a detailed report on the new Gulf situation post the ceasefire including our views on Brent future trajectory. Currently it is too early to give a definitive view in light of many failures on peace initiatives in the past two months. With Iran conflict continuing for more than 2 months now, we expect Fed to remain on hold for next several months till end CY26. Good inflation complimented by sustained service inflation implies an elevated core PCE which does not give space for Fed to cut in light of a stable employment situation. We are now bullish on Dollar and see 102 with a stop at 98, CMP is 99.25. In RoW macro data we have Australian CPI on Wednesday & Eurozone individual countries HICP inflation nos on Friday.

The Strait of Hormuz remains closed and the price of oil remains elevated leading to global bond selloff last week. While US equities mildly corrected on Friday, last week action was in bond markets. 10-year UST yields climbed 25bp over the past week and nearly 70bp since the conflict began. Markets have now fully priced one Fed hike by March, whereas last Friday that was closer to a 10% chance. US economy remains strong as seen in macro data and we now expect Q2 GDP at 2%. The economy benefited from the wave of personal tax stimulus in March and April, and business surveys suggest firms may have brought forward activity to get ahead of future price increases and supply chain delays. The fading tax stimulus would be less of a concern if oil prices were to quickly retrace in coming weeks, but that seems increasingly unlikely. We now expect Brent prices to remain sticky in the low $100/bbl even after the Strait reopening, eventually averaging $95/bbl for CY2026, as the bottleneck will shift from the physical chokepoint of the Strait to tanker availability and strong demand to rebuild inventories. Futures markets are not that far below and see crude still at $91 in December. Since the outbreak of the Middle East conflict our forecasts for headline PCE inflation this year have risen about 0.8% Q4/Q4, and real disposable income growth has slid by the same amount. While the job markets continues to remain stable, inflation worries are front and center. Inflation data released last week were broadly hawkish, pointing to signs of building price pressures. We have revised up our core PCE tracking estimate to 0.30% m-om, which translates to 3.3% y-o-y, significantly above the Fed’s target. Tech-related components are emerging as a new source of inflation, offsetting some slowdown in tariff-sensitive consumer goods. PPI’s price index for rubber and plastic products jumped in April. PPI’s truck transportation prices rose at their fastest pace in the series’ two-decade history, driven by higher fuel costs as well as limited capacity in the truck industry. In summary, Fed remains on hold for next several months. We still expect a 25 bps cut in Q4CY26 as an insurance cut if inflation shows signs of stabilising or if there is a resolution on SoH. This week in US macro data we have Fed minutes, S&P PMIs, IJC, Univ of Michigan survey. In dated supply, we have $16 BN of 20 yr UST auction on Wednesday & $19 BN of 10 year TIPS on Thursday. In RoW data we have Canada CPI, UK CPI, UK fiscal deficit, Japan CPI & GDP along with Chinese activity data.