Investors Want Cash Flow

MACRO FRAME

September’s CPI and PPI data continue to fuel expectations of a new hiking cycle from the Fed, while higher interest rates are adding to stress in credit markets.

STOCK INDEX FUTURES

Equity index futures are lower as traders digest PCE data, yesterday’s Fed hold, and Microsoft and Alphabet earnings. The market reaction to yesterday’s tech earnings shows clear that traders reward  cash generation while punishing rising spending. The earnings contrast puts self-funding at the center of the AI trade. Microsoft generated $18.6 billion in free cash flow, approximately $10 billion above expectations, alongside 48% Azure growth and stronger-than-expected revenue guidance. Alphabet’s cloud revenue more than doubled to $30.71 billion, but that strength was overshadowed by slower search growth, an advertising miss and a $9.07 billion free-cash-flow deficit. This morning’s economic data add a mixed macroeconomic backdrop. Third-quarter GDP grew at a 3.4% annualized rate, above the 3.2% consensus forecast, with consumption expanding 3.8% and AI-related investment contributing support. September, however, ended on a softer household note: nominal spending rose 0.5%, but real spending was essentially flat and real disposable income fell 0.3%. Amazon’s results tonight provide the next major test of cloud growth, cash generation and capital requirements.

CURRENCIES

US DOLLAR: The USD index is little changed at 102.25 as the market digests September PCE data. Above-forecast GDP growth supports the US growth outlook, while September PCE inflation remains too firm to suggest that the Fed’s work is complete. Headline prices rose 0.5% m/m and 3.6% y/y; core inflation increased 0.3% and 3.1%, matching expectations. December rate hike odds are priced at 85%, suggesting that for the dollar to continue an advance higher, those odds must move in tandem. Elsewhere, falling oil prices offer a competing force to dollar strength. Dollar direction is likely to remain a battle between increasing/falling rate hike expectations and the direction of oil prices.

EURO: The euro fell 0.20% to $1.1130. The euro remains constrained by French fiscal stress, but scope for a sharp reaction to ECB guidance today could significantly move the currency. Speculative short positions reached $18.89 billion, the largest in a decade, a forceful inflation message therefore could trigger some broad short covering. On the other hand, concern about growth and rising sovereign spreads (FR-DE) would reinforce the existing bearish narrative. The bank left rates on hold, leaving focus on what signals it gives on future monetary policy at the post meeting presser. Money market expectations are pricing a 63% chance of a hike in December and 67 bps of tightening over the next 12 months.

BRITISH POUND: Sterling is little changed at $1.3316. The Sterling’s relative resilience reflects the budget’s continuity rather than a major improvement in the fiscal outlook. The government retained its fiscal commitments, although headroom narrowed to £15 billion from £24 billion. The lack of a borrowing shock has pushed UK-specific risk into the background, allowing expectations of a November BoE hike to remain supportive.

JAPANESE YEN: The yen slipped 0.14% to 158.06 yen per dollar. The yen remains focused on Friday’s BOJ decision and tonight’s Tokyo CPI release. An unchanged rate is expected, leaving guidance on subsequent normalization as the more consequential signal. The bank is expected to hold rates steady, which should leave focus on its guidance on subsequent tightening. Strategists cited by Reuters found no evidence that Japanese institutions were bringing overseas funds home, yet. September core inflation above the BOJ’s 2% target supports the case for further normalization, while the majority of Reuters-polled economists expect a quarter-point increase in December.

AUSTRALIAN DOLLAR: The Aussie fell 0.44% to $0.7021 after hitting five-week highs overnight. Market expectations are that the Reserve Bank of Australia will have to raise rates next week in response to Q3 inflation data, which showed headline CPI rose 1.3% q/q, while quarterly trimmed-mean inflation accelerated to 1.0% q/q and 3.7% y/y. Fuel drove much of the headline acceleration. Automotive fuel jumped 9.4% m/m and 23.6% y/y as higher world oil prices fed through. Housing remained the largest contributor, but was easing. Housing inflation slowed to 5.2% y/y from 5.7%, contributing approximately 1.14 percentage points to headline inflation. The result has strengthened the case for RBA tightening in November. Money markets are now pricing an 84% chance of a hike and are fully priced for an increase before year-end.

TREASURY FUTURES

Yields fell in a flattening move across the curve in response to September’s PCE data. Inflation was broadly in line with the earlier forecasts rather than a fresh upside surprise. Headline PCE rose 0.5% on the month, accelerating from 0.3% in August, while core prices increased 0.3% for a second consecutive month. Annual headline and core inflation were 3.6% and 3.1%, respectively. Those readings fundamentally preserve the case for further tightening, especially if underlying gauges continue to show upside trends. GDP increased at a 3.4% annualized pace, but September’s PCE report showed that the 0.5% rise in nominal consumption translated into less than 0.1% growth after inflation. Real disposable income declined 0.3%, and the saving rate stood at 3.8%.Quarterly consumption grew at a 3.8% pace, but September’s flat real spending followed a 0.5% increase in August. Gasoline and other energy goods accounted for the largest increase in current-dollar spending, while motor-vehicle spending declined. The report points to a strong quarter ending with a visible purchasing-power squeeze. The Fed held at 3.75%–4.00% on a 10–2 vote Wednesday, with Cook and Hammack favoring a hike. Its stronger assessment of activity and continued inflation concern preserved a tightening bias, but Warsh’s confidence that inflation can fall without deliberately slowing growth encouraged markets to reduce expectations of increases in 2027. The policy implication is continued flexibility rather than an obvious change of course. Strong quarterly demand supports the case for another hike, while flat September real spending and declining real income argue for monitoring the cumulative strain on households.

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