All eyes on the US inflation reading, as markets climb back in Europe.

So far it has been a good week for European stocks.

The FTSE has lagged behind a bit although this morning’s rally has brought it back to within distance of its peers.

The FTSE 100 has added 1% so far today after being relatively flat on Monday and Tuesday. Morgan Stanley agreed with our own sentiment earlier in the week stating that:

‘Investor pessimism towards the UK is currently high; however, sentiment could shift if inflation starts to subside,’ strategists led by Graham Secker said in an e-mail note.

While UK assets have been offering relatively attractive valuations for some time, in the context of the last 20 years, UK equities and corporate bonds are the cheapest global assets around. A stronger pound will weaken results for the multinationals but it should help reduce inflation (you can’t win them all).

Once the UK has shown signs of taming inflation, we would expect a large move to the upside for UK stocks as pickers come looking for value.

The Stoxx 600 index advanced for a fourth day in Europe, with bank shares outperforming after the UK’s eight largest lenders all passed the Bank of England’s latest stress test. Virgin Money UK Plc surged more than 5% and Lloyds Banking Group Plc climbed 2.5%. Travel and leisure shares fell, led by Air France-KLM and IAG after Deutsche Bank cut its recommendations on the stocks.

Futures on the S&P 500 and Nasdaq 100 also edged higher after Tuesday’s solid gains as the US macroeconomic outlook still appears strong. This with a drop in inflation points to a solid 6 months for equities. Having said that, there are still a lot of nerves out there and a higher CPI print could cause the bulls to pause for thought.

The dollar weakened and Treasury yields dipped on expectations slowing US inflation will erode the case for more rate hikes.

A gauge of the greenback dropped to the lowest since April as traders focus on US consumer price data due later Wednesday, with a Bloomberg survey showing expectations for both core and headline inflation continuing to moderate in the face of the Federal Reserve’s monetary policy onslaught.

A trend of slowing inflation in the US could be pivotal for policymakers in the months ahead.  Officials have warned in recent weeks that higher rates will be needed to ensure price growth slows to the Fed’s 2% target, and a 25-basis-point increase is all but pencilled for July 26 after the pause in June. The policy path after that remains an open question.

“Both US and European equity markets have decoupled from the inflation narrative in recent months and this makes sense given the well-behaved decline in US inflation, which should continue with the June release today,” said Joachim Klement, head of strategy, accounting and sustainability at Liberum Capital.

“However, an upside surprise in core inflation could catch investors off guard and lead to more softness in markets.”

It’s odd that it’s never discussed why we’re all expecting a bigger drop this month but here it is:

Last June’s particularly high reading of 1.2% month over month will drop off the calculations.

It’s that simple. Since last June the average monthly reading is around 0.26% which would equate to 3.1% year over year.

With this month’s reading expected to be 0.1%, inflation is essentially already tamed so the FED should be very careful not to overreact where it’s not necessary. This is why we believe rates will not reach the heights that some are expecting. It’s simply not necessary and if they go too far, they will create a new problem, we just don’t know what it is yet.

If the US can maintain month-over-month readings of 0.1% to 0.2% then very shortly, inflation is at the 2% target. Let it happen and stop scaring everyone.

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Across Asia, shares were mixed last night, with slides in Japan and increases in Australia and India. Hong Kong stocks rose after data showed a strong credit expansion in the world’s second-largest economy. Chinese tech firms gained for a third day as unusual praise from the nation’s top economic planner and news of a meeting between officials and key companies stoked optimism over policy support for the sector.

In contrast to the gains in Hong Kong, China’s domestic benchmark CSI 300 index shed 0.4%, an indication that local investors would like to see stronger stimulus to salvage an ailing economy.

Also in the spotlight is the yen’s advancement beyond the key 140 level partly on speculation that the Bank of Japan will tweak policy later this month.

Elsewhere, the offshore yuan gained for a fifth day against the greenback, after China’s central bank extended support for the currency via a stronger-than-expected daily reference exchange rate.

The Kiwi dollar strengthened after initially paring gains on the Reserve Bank of New Zealand’s decision to keep interest rates unchanged for the first time in almost two years. The nation’s sovereign bond yields declined.

In commodities European natural gas prices fell to the lowest level in a month as the giant Norwegian Troll field is set to resume and demand remains subdued.

Benchmark futures in the Netherlands slumped as much as 2.8%, extending this week’s declines. While hot weather is blanketing parts of Europe and raising cooling needs, the continent’s higher-than-usual inventories have helped keep gas prices in check. Recent declines have made it more profitable for US liquefied natural gas exports to be shipped to Asian markets, according to BNEF.

Meanwhile, natural gas supplies from Norway are continuing to edge higher, with traders monitoring possible updates from the country’s network manager on maintenance schedules. If nothing changes, the giant Troll field will return on Thursday to full capacity after extended seasonal work.

UK natural gas is down over 2% again today which now means that it has dropped 74% in the last 12 months.

Here is a chart showing the last 5 years. As you can see, this is no longer a cause of inflation.

The only thing that is keeping inflation high in the UK now is increased wages. Unfortunately, we saw another rise again this week. It has to stop. We are driving our own inflation and until we stop pay rises, we can’t stop inflation.

All eyes are now on the US CPI figure which will be released at 1.30 pm UK time. If we get a 0.1% month-over-month figure, then we would disagree with the FED, the job is done.

Of course, politically, they can’t afford to say that; there will still be pressure to increase another 25 basis points at the next meeting, but if they push it too far, and don’t stop in time, who knows what they’ll break next?

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