PPI Cooling Reduces Rate Hike Pressure, but Core Prices and Long-Term Debt Supply Still Limit Rate Space

On August 14, the U.S. July PPI unexpectedly remained flat, with a year-on-year increase dropping to 4.7%. Coupled with the CPI released the previous day also showing cooling, this indicates that falling energy prices are alleviating inflationary pressures on the production side. Market bets on a Federal Reserve rate hike in September have decreased from about 50% to around 35% to 40%. However, the core final demand PPI, excluding food, energy, and trade services, rose by 0.4% month-on-month, indicating that underlying price pressures have not fully dissipated. Additionally, initial jobless claims rose to 209,000, reflecting some signs of cooling in the labor market.

What is truly noteworthy is that the cooling of inflation has not simultaneously resolved the long-term financing issues in the U.S. The 30-year U.S. Treasury bond auctioned at a yield of 5.216%, marking the highest issuance yield since 2001. In an environment of high fiscal deficits, increased debt supply, and the Federal Reserve no longer acting as the main buyer, long-term U.S. bonds require a higher term premium to absorb supply. This means that the cost of capital for the U.S. economy may not decline rapidly with the short-term cooling of inflation.

At the same time, after Japan intervened in the yen, the USD/JPY exchange rate approached 160 again, with some arbitrage traders taking advantage of the yen's rebound post-intervention to re-establish financing trades. As long as the U.S.-Japan interest rate differential exists, the yen's appeal as a low-cost financing currency is unlikely to fade. If the Bank of Japan raises interest rates or intervenes again, it could lead to greater fluctuations in exchange rates and leverage.

Overall, the July inflation data indeed provides the Federal Reserve with more observation space, but this does not equate to a rapid easing of financial conditions. While short-term interest rate pressures decrease, the U.S. fiscal deficit, long-term debt supply, energy prices, and yen arbitrage may still influence asset pricing through long-term yields and global capital costs. For the market, what is truly important moving forward is not just a single inflation data point, but whether the cooling of inflation can be sustained and whether long-term capital costs can decline in tandem.

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