US producer prices excluding food and energy rose 0.4% month on month in May. The reading came in below the 0.5% consensus expectation.
The data point indicates core pipeline inflation increased at a slower pace than forecast over the month. Markets will assess how the May outturn feeds into broader inflation trends and the policy outlook.
Federal Reserve Outlook And Rate Cut Expectations
The cooler-than-expected producer price data suggests inflationary pressures at the wholesale level are easing. This reinforces the view that the Federal Reserve will have less reason to maintain its restrictive monetary policy. We see this as a signal that the path of least resistance for interest rates is now lower.
This report follows recent Consumer Price Index data which showed annual inflation slowing to 3.1%, also missing expectations. Combined, these data points build a strong case for disinflation taking hold in the economy. The recent jobs report, which showed unemployment ticking up to 4.1%, further supports the argument for a more dovish central bank stance.
Given this, we are seeing a significant shift in interest rate expectations. The market is now pricing in a 70% probability of a rate cut by the September Fed meeting, up from just 45% last week. We anticipate this trend will continue as long as economic data does not surprise to the upside.
Investment Positioning Across Equities, Rates, And Currencies
For equity derivatives, we are increasing our exposure to upside in growth and technology sectors. This environment is favorable for assets sensitive to interest rates, so we are looking at buying call options on the Nasdaq 100. Historically, periods of falling inflation expectations have led to strong rallies in tech stocks, similar to what was seen in late 2023.
In the rates market, we are positioning for lower yields across the curve. We believe futures on the 2-year Treasury note offer a direct way to capitalize on changing Fed policy expectations. Selling call options on the VIX index also looks attractive, as a less aggressive Fed should reduce overall market volatility.
We also anticipate weakness in the US dollar as its yield advantage narrows. This suggests opportunities in currency derivatives, specifically buying calls on the Euro or Japanese Yen against the dollar. We are positioning for the US Dollar Index (DXY) to break below its recent support level of 103.50 in the coming weeks.
