The latest data suggests that US inflation is falling, though perhaps not as fast as the US Federal Reserve would wish. In Europe, inflation may be on a path too low for the ECB’s comfort. Meanwhile, in China, disinflationary pressures are mounting. Whichever way you look at it, the US is the exception.
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US equities riding high
US equity markets remain well orientated. The S&P 500 closed at a record high on 11 October, propelled by a rally in financial stocks. The index is now up by about 22% year-to-date. US stocks face a period of significant event risk over the next month, not least with the US presidential elections on 5 November.
The equity market’s immediate focus is on third-quarter earnings. The reporting season got off to a good start on 11 October. Several large US banks beat quarterly earnings expectations. The US consumer remains resilient, with revised data showing continued strength in households’ balance sheets. Initial earnings reports are consistent with the current narrative for a soft landing by the US economy – slowing growth, lower inflation, and no drastic rise in unemployment. [1]
The second half of October will see earnings reports from a further two-thirds of the companies making up the S&P 500 index, including some of the largest tech companies.
Finally, in the last week of the month, publication of the key US non-farm payrolls and manufacturing data will pave the way for the rate-setting meeting of the Federal Open Market Committee on 7 November.
US inflation fell again in September
US headline inflation (CPI) fell to 2.4% in September, marking the sixth consecutive month the rate has fallen.
The data reinforced expectations that the Federal Reserve (the Fed) will cut official rates by 25 basis points (bp) at the FOMC meeting on 7 November.
Markets were pricing in a roughly 90% chance of such a cut from the Fed in November following the data, compared with 80% beforehand.
But core inflation is not falling
Core inflation, however, has continued to exceed expectations. CPI excluding the volatile food and energy price components stabilised at 3.3% in September; the personal consumption expenditures excluding food and energy deflator (core PCE) – the Fed’s preferred measure of inflation – rose from 2.6% to 2.7% in August.
Currently, core inflation is essentially unchanged relative to its level a year ago (see Exhibit 1).
So far, equity markets are unperturbed by this, perhaps on the basis that, as the US economy cools and the Fed loosens policy, the downward path of inflation may still be bumpy.
If, however, core readings do not fall between now and year end, the Fed may be obliged to react by slowing the pace of its rate cuts. With US growth still above trend and wages rising at 4% per year, higher-for-longer interest rates are showing up in the US bond market where the yield of the 10-year Treasury has risen to around 4.1%.
Minutes of the FOMC meeting in September revealed that the decision to open the cycle of interest rate cuts with a 50bp reduction was not unanimous. FOMC member Michelle Bowman became the first Fed governor to dissent since 2005. She argued that a more ‘measured’ quarter-point cut would ‘avoid unnecessarily stoking demand’.
A problem with too little inflation for the ECB?
After cutting its key deposit rate by 25bp in June and September, the European Central Bank (ECB) is expected to cut it again on 17 October to 3.5%. This was not anticipated after the Governing Council’s last meeting in September, but weak economic growth in the eurozone and a sharper fall in inflation than the ECB anticipated mean markets are now convinced the ECB will lower the deposit rate again.
There are concerns that the ECB, in contrast to the Fed, may be facing the prospect of too little rather than too much inflation. In September, annual inflation fell to 1.8%, putting it below the ECB’s 2% medium-term target for the first time in over three years.
An uncomfortably low level of inflation has been an issue for the ECB in the past to the extent that in mid-2021, the ECB revised up its target for inflation from ‘close to, but below 2%’ to 2%.
With disinflationary winds blowing from China via weak demand for European manufacturing goods and highly competitive Chinese exports, the eurozone remains vulnerable via disinflation.
Germany’s economy to contract again in 2025
Germany, the eurozone’s largest economy, faces its first two-year recession since reunification in 1990. The German government last week downgraded its 2024 growth forecast to -0.2% from +0.3%.
Robert Habeck, economy minister, said Germany had made real progress in tackling higher energy costs in the wake of Russia’s invasion of the Ukraine, but long-term structural problems related to an ageing population, years of under-investment in infrastructure, and excessive bureaucracy continue to constrain growth.
He said the current period of global economic weakness – and especially developments in China – were making life difficult for Germany as a nation of exporters.
Unfortunately, the latest news from China does not suggest an improvement in the economic outlook there is imminent.
Deflationary pressures mount in China
Data published on 13 October showed China’s consumer price inflation rose by 0.4% year-on-year in September – lower than forecasts looking for a 0.6% gain and down from 0.6% in August. Producer price inflation fell to -2.8% year-on-year (relative to forecasts of a decline of 2.6%). The fall accelerated from 1.8% in August and was the steepest decline in six months.
This week, strong trade numbers, powered by exports, are likely to be offset by weak data for China’s third-quarter GDP (on 18 October). The numbers would underline China’s ‘two-speed economy’ where overcapacity drives the export machine, but internal demand is chronically weak in the wake of the property crisis.
Investors are waiting for Beijing to detail extra fiscal spending plans to back up the monetary stimulus from late September. So far, they have been disappointed by a lack of detail in government announcements.
Chinese stocks tumbled by more than 7% on 9 October, after a 10-day rally, because of investors’ concerns that Beijing’s stimulus efforts will not be enough to revive growth.
On 12 October, the Ministry of Finance held a press conference, but gave no details on the size and scope of the stimulus package. Investors now await an announcement of a potential ‘Beijing Bazooka’ in coming weeks when the National People’s Congress meets.
