The gift that keeps on giving By Reuters

A look at the day ahead in European and global markets from Tom Westbrook

Before they head off for the Christmas and year-end break, markets will get one last glimpse of the U.S. inflation picture with Friday’s Personal Consumption Expenditure index data.

A low number could validate what’s been an astonishing bond market rally over the past two months. A high number could challenge the market’s aggressive positioning.

Euphoria in the wake of signals by the Federal Reserve that rate hikes are done – and that cuts will come in for consideration – has interest-rate futures markets pricing 150 basis points of cuts next year.

Traders see an 83% chance of a rate cut in March and a 12% chance it is a super-sized 50 basis points. The , at 3.9%, is down more than 110 bps from just above 5% in late October.

The wager is that retreating inflation will push the Fed to cut quickly, to prevent real rates from rising. Two-thirds of the 251 participants in the Bank of America’s December fund manager survey see a “soft landing” for the U.S. economy and investors are their most bullish on bonds since March 2009.

Thursday’s downward revision to the PCE in third-quarter growth data bodes well for a downside surprise when the November number is released later today, although Wednesday’s sudden sell-off in U.S. stocks is a reminder that holiday-thinned markets will be volatile when disturbed.

British growth and retail sales data is also due on Friday, but that’s already been overshadowed by this week’s inflation surprise that sent sterling sliding and the flying, as sharply slowing inflation paves the way for rate cuts early in 2024.

Trade in Asia was cautious and the , down 4.6% since the start of November, hovered at 101.86 as investors awaited the PCE number.

With the Fed no longer seen as an outlier that would keep rates high through 2024, the dollar has been under pressure and the euro has found a foothold above $1.10. The yen – the year’s worst performing G10 currency – has also found support.

The Bank of Japan disappointed markets by giving no signal of a policy shift at this week’s meeting. But there’s a growing consensus that it will act in the spring and a record 73% of BofA survey respondents think the yen is undervalued.

Key developments that could influence markets on Friday:

– British GDP, retail sales

– U.S. core PCE

(By Tom Westbrook; Editing by Edmund Klamann)