Equities managed to regain ground last week thanks to solid results from large US tech companies. Stabilising bond yields, particularly at the short end of the yield curves, may have contributed to this rise. Market expectations are for the first rate cut by the US Federal Reserve to be delayed after the release of higher-than-expected inflation data, but the assumption of policy easing later in 2024 has not been quashed.
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An update on US inflation
Investor attention was focused on the latest personal expenditure price index, more specifically on the closely watched core PCE (excluding food and energy), but this time on a quarterly basis. The first-quarter measure rose by 3.7% annualised against the 3.4% consensus forecast, suggesting a sharp rebound in inflation in March.
However, the monthly core PCE figure was somewhat reassuring. Data showed that the numbers had been revised up for January (to 0.5%) and February (to 0.27%), so that the change in March was ‘only’ 0.32%.
Year-on-year, this gauge of inflation – the Fed’s preferred measure – eased slightly (from 2.84% to 2.82%). However, for the Fed’s forecast of core inflation at 2.6% in the fourth quarter of 2024 to materialise, monthly gains would need to be less than 0.2% until the end of the year. In addition, the supercore PCE (core excluding shelter) nudged up from 3.43% in February to 3.5% in March.
Should we be concerned?
We have seen disappointing progress in slowing inflation since the beginning of the year, but there appear to be no doubts over the trend of slower price increases.
Fed Chair Jerome Powell, however, has acknowledged that “it will likely take more time for FOMC (members) to be confident that inflation will return to 2%”. So, the Fed’s willingness to act over the summer might be in question. That could cause market expectations of a cut in key US rates to ebb, with consequences for fixed income markets and risky assets.
Over the last week of April, ahead of the next US monetary policy decision on 1 May, equities managed to regain ground thanks to upbeat results from US tech giants and as bond yields stabilised (after having risen sharply since 10 April). Yields at the front end of the curve even eased.
So, arguably, the scenario of a soft landing and regular monetary policy easing that was reflected in the first-quarter performances of risky assets, has suffered a setback. In our view, however, the rise in core inflation in developed economies is not a new trend and we expect inflation to slow gradually in the coming months.
Key rate cuts are therefore still likely. The rate cutting cycle has started already – in March, Swiss rates were cut – and the ECB appears ready to act in June, even if the Fed’s timetable could now be adjusted to take November’s US elections into account.
US growth remains robust. but…
The first estimate of first-quarter GDP growth (1.6% annualised) disappointed: Consensus expectations had been for 2.5%, while the Federal Reserve of Atlanta (GDPNow) running estimate of growth had been 2.7%.
However, the details of the GDP news were favourable: Private consumption grew by 2.5%, business investment by 2.9% and the contribution of inventories and net export were negative (-0.35pp and -0.86pp, respectively). The strength of imports explains the latter result and shows domestic demand remained strong in Q1.
The improvement in housing and construction activity in recent months was reflected in the national accounts by a 13.9% increase in residential investment (after two years of contraction).
Private final domestic demand grew by 3.1% (after 3.3% in the fourth quarter). Inflation-adjusted personal consumption spending rose by 0.5% in March after 0.5% in February and -0.3% in January. This underscores the solid momentum at the end of the quarter that had already been seen in retail sales data published earlier in March.
However, flash estimates based on purchasing managers’ survey data (PMI) showed a slowdown in activity in April in the US, in particular, a sharp decline in employment in services, down from 51.1 to 47.3. That is a post-pandemic low. Consumer confidence fell in April too.
Against this background, one or two rate cuts look likely in 2024, even if market expectations of the Fed’s first cut have been pushed back by both markets and professional forecasters.
Collateral damage – The yen
Adjusted expectations around the Fed’s and the Bank of Japan’s monetary policy have hit the foreign exchange market. The US dollar rose as hopes for a cut in Fed rates in June faded, sending the USD/JPY rate (at 151.35 at the end of March) quickly to above 155. That is its highest since June 1990.
The fall of the yen led the US Treasury Secretary, the Japanese Finance Minister and the South Korean Finance Minister to issue a joint statement expressing ‘serious concerns’ over the recent sharp depreciation of the yen – and the Korean won – and a commitment to “continue to consult closely on foreign exchange market developments.”
Despite rather hawkish Bank of Japan comments at its latest monetary policy meeting, the lack of clear forward guidance on a future rise in the Japanese policy rate weighed on the yen. USD/JPY rose to above 158, driving the yen to its lowest against the dollar since April 1990. Such a level increases the likelihood of intervention in the foreign exchange market. On 29 April, the USD/JPY rose to above 160 before falling back sharply to 155. To be continued…
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