PCE Data Matches Forecasts

MACRO FRAME

The US and Iran have agreed to a framework deal to end their conflict, reopen the Strait of Hormuz, and move toward broader negotiations—though major issues (Lebanon conflict, nuclear program) are not fully resolved yet.

STOCK INDEX FUTURES

Equity index futures were mostly higher overnight with the Nasdaq leading gains in a renewed AI-chip rally following Micron’s earnings. Micron quadrupled revenue, largely validating the AI capex cycle, supporting the view for some investors that elevated valuations can be sustained as long as this growth narrative holds. PCE rose 0.4% MoM in May, matching April’s pace. The YoY reading rose to 4.1%, up from 4.0% in April. Core PCE came in at +0.3% MoM and +3.4% YoY, which is the more closely Fed-watched gauge.

The recent downward pressure on technology and semiconductor stocks has been the combination between a technical market structure indicating historically overbought levels, and fundamentals that, while supportive and real, raise questions as to whether or not near-term earnings and future demand can justify current price levels. The backdrop of a higher-for-longer rate environment and a growing debt overhang in enterprise software have shifted the risk/reward profile for investors regarding concentration in the momentum-driven tech trade, likely explaining the rotation away from tech in recent sessions. The catalyst that triggered the most recent selloff, SK Hynix’s announcement that it was “shifting its focus to the general-purpose DRAM market.” That was interpreted by investors as a trillion-dollar chipmaker stepping back from the AI memory market, causing an immediate shift out of the AI hardware complex. The fundamental question for the indexes, mainly the tech-related momentum trade, is whether or not capex requirements outrun earnings estimates and demand as investors try to price outcomes they cannot yet observe.

Defensive positioning could offer protection against these dynamics, especially as the Fed’s higher-for-longer stance weighs on near-term sentiment. The valuation discount in defensives relative to their own history and growth is historically wide, providing a margin of safety that momentum tech no longer offers.

Watch point: The Fed’s recent policy meeting has led markets to expect a hike in October. However, a sustained drop in the price of oil could challenge some policymakers views of whether tightening could be necessary. Still, policy is biased to a move upwards, while the recent sell-off reinforces the case for selectively adding some defensive positioning to the ongoing tech‑led momentum.

CURRENCIES

US DOLLAR: The USD index rose near a 13-month high ahead of today’s PCE data. The two‑year Treasury yield has risen about 14 bps this month to roughly 4.16%, vs. a 2 bp move higher in German two‑year yields and a 9 bp decline in UK two‑year gilts, underscoring the widening US interest rate advantage. The hawkish shift in Fed policy expectations has been supportive as investors are leaning into the idea that the Fed will back up its talk on inflation. Meanwhile, another source of demand has been speculative purchasing of dollars, as seen by the strongest net long in dollar positions in over 16 months, according to the CFTC. A strong print in today’s inflation data is likely to reinforce the rate path and support the dollar, while a reading that comes in lower than expected will ease near-term dollar strength. Traders are placing around a 71% chance of a hike in September and are fully priced for a hike by October. The dollar is has been driven more by rates and macro factors than geopolitical developments over the last couple of sessions, as falling oil prices and direct US-Iran talks would otherwise see a flight away from dollar safety. Still, ongoing geopolitical uncertainty and Iran’s willingness to close the Strait are limiting the downside to the dollar.

Watch point: A durable peace agreement and drop in oil prices is likely to unwind expectations of Fed policy tightening, though the FOMC meeting presented a sharp reversal in recent market dynamics, with the dollar now finding stronger support against foreign currencies.

EURO: The euro is being dragged down by the widening EU-US rate differential and recent comments from European Central Bank President Christine Lagarge, who downplayed the effects of second-round inflation worries. Expectations of a rate hike from the ECB show traders are fully priced for an October hike. For the ECB, policy is likely to remain biased upwards, though a continued easing in services inflation could dull some expectations of a move upwards. The euro is likely to benefit from risk-on flows away from the dollar, though increased expectations of Fed tightening, a sharp reversal from earlier dynamics, now offer fresh pressure against the euro. On the data front, PMI surveys showed that in the prices index, input cost inflation eased to its slowest pace since just before the outbreak of war in the Middle East, with lower energy prices filtering through to businesses. Output price inflation also slowed, though by less than input costs. Notably, most responses were collected before the US-Iran ceasefire MOU was signed on June 17, meaning the data doesn’t fully capture any demand or sentiment uplift from that development.

Watch point: A peace deal, restoration of oil flows through the Strait, and easing services inflation are likely to push back tightening expectations, though policy expectations are still biased upwards.

BRITISH POUND: Andy Burnham looks set to become the new Prime Minister lending focus to who the pick to become finance minister will be. Current finance minister Rachel Reeves is likely to leave her role if Burnham becomes PM, media outlets reported on Tuesday and Wednesday, with pro-business former health secretary Wes Streeting among the names tipped for the job. Broadly, the leadership succession is likely to have little effect on the pound as an orderly transfer of power looks set and as markets have priced in Starmer’s exit for some time. Still, markets remain highly sensitive to fiscal credibility, particularly given the UK’s elevated borrowing costs and structurally weak growth backdrop. For now, the rate backdrop is likely to be the significant driver in price action for the pound. Bank of England Governor Andrew Bailey said that it remains too early to call off the inflation risk during the BoE’s most recent meeting. Looking ahead, the bar for further tightening appears high and contingent on renewed energy or expectations, while a sustained easing in inflation and confirmation of a softer labor market would keep the debate focused on how long policy must stay restrictive rather than any tightening.

JAPANESE YEN: The yen was little changed overnight at 161.85 yen per dollar. The yen is trading near 40-year lows, a break above the 161.96 level would take it to its weakest level since 1986. Volatility in the yen should be expected from traders as the currency faces intervention risks from the government.  Fed pricing toward tighter policy, persistent rate differentials against Japan, and the lack of effectiveness of prior interventions without a sound Bank of Japan backdrop all continue to pressure the currency. Despite Japan’s Ministry of Finance signaling willingness to intervene, market skepticism of that effectiveness, largely resulting in a intervention vs. hawkish Fed and strong US data trade.

The BoJ’s recent rate hike offered the yen no support despite rates being at their highest level in 31 years. With policy rates in Japan still deeply negative in real terms, incremental moves are unlikely to deliver a durable yen rebound. Instead, markets are increasingly focused on Japan’s heavy debt load, while political support for a weaker yen, equity benefits from FX depreciation, and reluctance to tackle the debt overhang suggest any sustained yen strength will require more than rate hikes alone. The market sees a total of 20 bps of tightening by year-end. The yen has now sustained a break above the 160 support level.

Watch point: With the yen sustaining a break above the 160 level, intervention from the government appears to be the greatest near-term risk against further depreciation. Without intervention, the yen is likely to weaken against major peers.

AUSTRALIAN DOLLAR: The Aussie fell 0.13% to $0.6890, holding near 11-week lows as dollar strength weighs on the currency. Australian data showed employment rose by 40,300 in May, though that was balanced by a sharp downward revision for April to a 40,600 drop. The unemployment rate eased back a tick to 4.4%. Headline Australian CPI fell 0.7% MoM in May (bigger drop than expected), pulling annual inflation down to 4.0%, but trimmed‑mean core rose 0.4% MoM and accelerated to 3.6% YoY, keeping underlying price pressures elevated. Recent pressure against the Aussie has come from stronger Fed rate hike pricing, which has led to a compression in interest rate differentials. Still, progress in US-Iran talks are largely supportive of the risk-sensitive currency. Markets are pricing around a 50% probability of another hike from the Reserve Bank of Australia this year. The Bias for the RBA remains toward further tightening as the bank is seen as having a lower threshold to hike again.

Watch point: While a durable end to the war would alleviate downside risks to growth and moderate inflation pressures, ongoing pass-through into broader prices is likely to keep the RBA on a tightening path.

TREASURY FUTURES

Yields moved lower across the curve following today’s PCE data. While oil prices have dropped in recent sessions, yields have remained higher in the face of the hawkish shift in Fed expectations. The hawkishness has been driven by resilient economic data, sticky inflation, and a perceived hawkish reaction from Chair Warsh. The consensus market pricing of around 37bps of hikes in 2026. The recent Fed meeting has reinforced upward pressure on front-end yields, which has significantly compressed the 2/10 spread to 25 bps from 40 bps seven days ago. The key tension remains a more hawkish Fed reaction function and market pricing, leaving Treasuries vulnerable to further repricing if incoming data supports the Fed’s tightening bias. Warsh’s characterized the inflation overshoot as supply-driven rather than demand-driven, leaving room for yields to eventually ease if oil prices continue to hold a substantial drop, though today’s data and recent price action have suggested that the bond market is looking past any near-term drop in oil prices on the expectation that higher prices have already made their way into the economy.

Watch point: The Warsh-led Fed held on rates and signaled broad institutional change. Mainly, markets should expect fewer words from the Fed and less policy signaling, raising near-term rate volatility with incoming data.

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