A New Unfavorable Trajectory for US Inflation and Doubts About Its Return to 2%.
THE FACTS
US inflation surprises on the upside for the fourth consecutive month (3.5% for the headline and 3.8% for the core). On an annual basis, inflation fails to break through a new lower level, with the core component stabilizing around 4% since October.
Sources : Fed Saint Louis, Richelieu Group
The details are not much more reassuring at this stage. Indeed, “services excluding rent” inflation remains at levels incompatible with a sustainable return of prices to 2%. A more pronounced slowdown in demand is thus necessary, an element that remains central to the scenario for 2024. This report on firmer-than-expected inflation undermines the Fed’s hope of consolidating the prospects for a soft landing by rolling back some of last year’s interest rate hikes. While wage growth continues to slow, the inflation process is the subject of great debate. The main rise in core inflation comes from housing and auto insurance, which could reflect a wave resulting from the initial rise in car prices.
Sources : Bloomberg, X
Housing-related inflation continues to decline year-over-year… but this decline is becoming less marked and is offset by the “health” component, whose contribution to the core CPI increases by about 10 bps. To initiate any kind of “mid-cycle adjustment,” the Fed needed to see an obvious weakness in the economy or lower inflation figures that were the norm in the second half of 2023. Three months into 2024, we have neither; hence, the cuts are postponed!
US Inflation Variation over 12, 6, and 3 Months
Sources : X, WSJ
IMPACT ON THE SCENARIO
Our scenario remains unchanged regarding the number of cuts this year (1 or 2, with the second in December). The first rate cut should not occur until July, implying a 50 bp reduction this year. Given these uncertainties, it will be difficult for the Fed to maintain the same monetary easing schedule, especially since the majority of members in March in favor of 3 cuts was very close (10 vs 9 in favor of 2 cuts or fewer in 2024). We still anticipate an acceleration of monetary easing in 2025 (we maintain a target rate of 3.5%-3.5% to be reached by the end of 2025).
Jerome Powell must temper household wealth through real estate, a choice made difficult by the electoral context.
US Real Estate Price Index and Annual Variation
Sources : Bloomberg, Richelieu Group
The impact on American politics and the global economy is not negligible this time.
A new surge in inflation in the United States jeopardizes Joe Biden’s reelection message, compromising his ability to defend his economic record against Donald Trump. Although the American economy has added more than 15 million jobs under President Biden’s tenure, the rise in inflation during his term has cast a shadow on his economic management, becoming a major political weakness ahead of the November elections. With the Consumer Price Index having increased by 25% since Biden’s inauguration in January 2021, any slowdown in the fight against inflation could harm his reelection prospects.
US Consumer Price Index
Sources : Bloomberg, Groupe Richelieu
At the global economic level, the Federal Reserve maintaining rates at these levels longer than expected places other central banks in a difficult position regarding their monetary policy and affects economies that are struggling (China), starting their recovery (Europe), or attempting to boost their currencies by timidly raising rates (Japan). The economic health of the United States is a unique feature that is starting to impact the rest of the world adversely.
Contrary to recent months, during which the rise in real rates did not prevent the progression of risky assets amid an improvement in growth prospects beyond the Atlantic, yesterday’s session witnessed much greater sensitivity, but only in the United States, as the issue of inflation control reemerges. To initiate any kind of “mid-cycle adjustment,” the Fed needed to observe either a clear weakness in the economy or lower inflation figures, which were the norm in the second half of 2023. Three months into the start of 2024, we have neither; the rate cuts are postponed.
IMPACT ON MARKETS
In the short term, this should have a significant impact on risky assets. Fed officials have tried to stay cool in the face of higher inflation at the end of the year, given the well-documented seasonality issues, partly explaining why March price figures are of greater importance.
The Indeed wage tracker continues to decelerate, reaching its lowest level since September 2020, and inflation is expected to moderate in the coming months. This is the main reason why we are not turning negative on stocks. However, we are more cautious and believe that investments should be made at the lower bounds of neutrality.
US indeed wage tracker versus CPI Services
Sources : Indeed, X
Our objectives regarding the indices remain unchanged:
Source : Richelieu Group
In the short term, the dollar could strengthen (lower bound 1.05). The ECB will keep a close eye on the Federal Reserve, as speculation mounts that it may cut rates less this year than previously expected. Some will warn of the dangers to the euro and imported inflation from outpacing the Fed in the easing cycle, although the general view within the ECB is that a “significant divergence” between the two central banks’ rate paths would be concerning. In the eurozone, the story is quite different. Economic growth is barely recovering, and the ECB will need to be much more accommodating. The real story remains for now a disinflationary process that is not challenged, thanks, it is true, to very “measured” growth.
Unlike the Fed, the ECB would have no reason not to cut in June. Regarding interest rates, for the same reasons, we think that the bond stress brought on by the publication of US inflation figures presents clearer opportunities on sovereign and Investment Grade bond rates. In our scenario, 4.5% on the 10-year US was a peak. In the US, our year-end target on the 10-year US is now 4.10% (instead of 3.80%), taking into account the economic slowdown at the end of the year. The reduction of the Fed’s monetary policy tightening should avoid too much pressure on sovereign rates. Corporate Investment Grade and High Yield bond markets are of interest despite compressed spreads for the latter, with yields being attractive ahead of rate cuts mainly in Europe (lengthening duration). On the US Investment Grade, yields have been rising since the beginning of 2024. The scenario of a Fed disappointing the market regarding its monetary policy should allow the moderation of QT from May to benefit only sovereign securities. The maintenance of higher-than-expected rates should weaken the most vulnerable segments. We remain cautious on US HY.
10-Year Sovereign Yields
Sources : Bloomberg, Richelieu Group
