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Marketmind: Rate cut cat-and-mouse game

[January 16, 2024] A look at the day ahead in U.S. and global markets from Mike Dolan

A shortened U.S. markets week starts on the back foot as Friday's slightly peculiar interest rate cut ebullience cools a touch again while U.S. banking giants resume the corporate earnings season.

Wall St has a lot to unpack from a three-day weekend packed with political developments home and abroad.

Taiwan's ruling Democratic Progressive Party won the presidential election, but lost its majority in parliament. And oil and natural gas prices continued to shrug off ongoing threats and attacks on Red Sea shipping after U.S. and UK forces hit back at Houthi protagonists in Yemen late last week.

Donald Trump secured a resounding win in the first 2024 Republican presidential contest in Iowa on Monday, largely as expected and asserting control over the party as he seeks an election rematch with President Joe Biden.

But U.S. congressional leaders managed to agree on a stopgap spending bill to keep the federal government funded into March and avert a partial government shutdown starting late next week.

But it's the Federal Reserve rate cut picture that still dominates, with what seemed at first like a mixed picture on inflation from consumer and producer price reports for last month eventually spurring rate cut speculation even more due to a read-across to the Fed's favored PCE measure.

Falling input prices and soft components of the CPI that have bigger weightings in the PCE inflation gauge due next week have actually prompted some banks to cut their forecast on the latter, with six-month annualized PCE inflation seen falling below the Fed's 2% target.

Barclays, for one, brought its forecast for the first Fed cut to March from June as a result.

Although some central banking pushback again since, mainly from European officials over the weekend, has dampened that speculation a little and sees a more negative start to the week, pretty aggressive easing remains in the price.

While ECB officials talk tough and managed to nudged rate cut bets there into April, the weakness of Germany's economy last year and plunging inflation expectations among European households support bullish rate markets.

Bank of England chief Andrew Bailey, speaking in parliament later on Tuesday, will also be cheered by news of ebbing wage inflation.

U.S. rates markets continue to chomp at the bit.

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People walk around the Financial District near the New York Stock Exchange (NYSE) in New York, U.S., December 29, 2023. REUTERS/Eduardo Munoz/File Photo

Fed futures still see almost 160 basis points of rate cuts this year, with more than a 70% chance they start in March.

Two-year Treasury yields - which had plunged to their lowest since May on Friday - have firmed up about 10bps since to 4.21%, but ten-year yields remain unchanged. A sharp disinversion of the 2-10-year yield curve this month to its narrowest levels in about 18 months took a breather Monday.

A record 91% of global investors expect lower short-term bond yields in 12 months' time, a January survey of fund managers published by Bank of America on Tuesday showed.

With Goldman Sachs and Morgan Stanley up later in what's been a mixed fourth quarter earnings picture for the big banks so far, Wall St stock futures were off about 0.5%.

Some merger activity also caught attention.

U.S. private equity firm General Atlantic said on Tuesday that it has entered into an agreement to buy UK-based infrastructure investor Actis.

And brokerages Panmure Gordon and Liberum on Tuesday announced an all-share merger to create what they say will be the UK's largest independent investment bank.

Key diary items that may provide direction to U.S. markets later on Tuesday:

* U.S. corporate earnings: Goldman Sachs, Morgan Stanley, PNC

* New York Fed Jan manufacturing survey; Canada Dec inflation, housing starts

* Federal Reserve Board Governor Christopher Waller; Bank of England Governor Andrew Bailey testifies to parliament;

* World Economic Forum in Davos

* ECOFIN meeting of European Union finance ministers, with European Central Bank board member Luis de Guindos attending

* U.S. Treasury auctions 3-, 6-month bills

(By Mike Dolan, editing by Christina Fincher, mike.dolan@thomsonreuters.com)

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