Inflation cools, Oracle on fire

Surprisingly soft U.S. producer price inflation figures on Wednesday spurred outside bets on a half a percentage point cut in U.S. interest rates next week, pushing Wall Street to new highs, lifting gold, and pulling bond yields lower.

In my column today I look at how the combination of Fed rate cuts and sticky inflation will reduce ‘real’ U.S. rates and yields, spelling bad news for the dollar.

If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.

The extraordinary 43% surge in Oracle’s share price thrusts the whole AI bubble debate back into the sharpest focus. This is not a penny stock, startup or meme stock, this is a long-established tech giant, which is now suddenly close to joining the exclusive $1 trillion market cap club.

Oracle said on Tuesday it expects booked revenue at its Oracle Cloud Infrastructure business to exceed half a trillion dollars. Shares traded at nearly 50x estimated 12-month forward earnings on Wednesday, the highest since the dotcom crash, when its forward PE topped 120.

The composition - and independence - of the Federal Reserve in President Donald Trump’s second term continues to dominate Fed watchers’ thinking, with the focus right now centered on Governor Lisa Cook and board nominee Stephen Miran.

A federal judge has temporarily blocked Trump from firing Cook while Miran, currently a White House economic adviser, has cleared a U.S. Senate hurdle. Meanwhile, Trump on Wednesday lambasted Fed Chair Jerome Powell, calling him “a total disaster, who doesn’t have a clue” and insisting that the Fed slash interest rates.

Oil prices spiked on Wednesday after an Israeli attack in Qatar’s capital Doha, and the Polish zloty had its worst day in over a month after Poland shot down suspected Russian drones in its airspace, the first time a member of NATO is known to have fired shots during Russia’s war in Ukraine.

The moves weren’t too dramatic, but were a reminder to investors of the political risk in pockets around the world that can quickly spill over into asset prices and market volatility.

‘Real’ rate dip threatens to pull down dollar

The dollar has been beaten down this year as investors have priced in a resumption of the Federal Reserve’s rate-cutting cycle. But even if lower nominal rates are already reflected in the greenback’s price, lower ‘real’ rates may not be.

The greenback has gotten a bit of respite recently after recording its worst start to any calendar year since the era of free-floating exchange rates was introduced over 50 years ago. But it will face a renewed headwind if its real interest rate support evaporates, which currently seems likely.

If the Fed pulls the rate cut trigger next week, as expected, it will be doing so with inflation around 3% - a percentage point above the central bank’s 2% target. Further easing amid sticky prices means the gap between the U.S.’s inflation-adjusted or ‘real’ interest rate and those of its developed market peers should narrow – bad news for the dollar.

The difference in inflation-adjusted or ‘real’ interest rates and yields is often thought to play the biggest role in determining the relative returns and purchasing power of currencies.

Depending on what cut of annual inflation you use, the ‘real’ federal funds rate right now is somewhere in the 1.3-1.8% range. That’s much higher than equivalent rates in the euro zone, Britain and most notably Japan, where the real policy rate is deeply negative.