20th May 2024
Markets last week
US inflation cooled for the first time in six months, with most progress seen in core inflation which dropped to the slowest rate in three years
The positive surprise on inflation was a relief for the bond market, leading to a fall in US Treasury yields
Signs of a slowdown in US economic output, from a high starting level, point to a potential further subsidence of inflationary pressures and ultimately interest rate cuts
Services inflation remains too high, largely due to continued wage pressures
The US equity market rose 1.5% in US dollar terms, with large cap growth stocks performing best. US dollar weakness eroded much of the gains in sterling terms
The People’s Bank of China (PBOC) announced a significant support package to counter the economic pressure from the housing crisis and weak consumer confidence
China began selling the first batch of its 1trn yuan ($138bn) special sovereign bonds, the fourth such sale in 26 years
China is showing signs of a mixed economic recovery but continues to struggle with deflationary pressures
Last week saw strong performance in the metals market, with solid gains in both industrial and precious metals
Copper surged 6.6% approaching a record high, while nickel jumped over 11%
Silver hit an 11-year high rising 11.7% and gold neared its all-time peak from April rising 2.3%
The week ahead
UK inflation: There has been solid disinflationary progress in the UK so far this year and this is expected to accelerate in April. This progress on inflation would likely pave the way for an interest rate cut in the coming months
Japanese Inflation: This is expected to slow from 2.7% in March to 2.4% in April. The Bank of Japan (BoJ) has recently begun to back away from their ultra-loose monetary policies of negative interest rates and yield curve control. The swap market is pricing in two hikes for 2024.
Analysis
US inflation set the tone last week as it cooled for the first time in six months and pointed to a resumption of the dissipation of price pressures – April’s inflation data was released on Wednesday. Most of the progress was seen in core inflation (excludes volatile food and energy components) which dropped to the slowest rate in three years and ended a three-month streak of higher-than-expected rises.
The positive surprise on inflation was a welcome relief for the bond market which has been on the back foot since the start of this year. As a result, it was bonds that led the charge with US Treasury yields falling across the curve, bond prices rise when yields fall. The 10-year US Treasury yield fell from 4.5% to 4.34% mid-week, before giving a little back to close at 4.42%.
Although it is only one inflation print and therefore it shouldn’t be over emphasised as economic data is inherently noisy, it is a step in the right direction for the Federal Reserve. It is also bolstered by recent weaker economic data which points to a potential healthy slowdown in US economic output (from a very high starting point). This includes a softening of the labour market, including weaker payrolls, a pick-up in unemployment and a lower quits rate. Consumer sentiment has also fallen more than expected and retail sales data was notably weak. We are still in an environment where bad news is good news when it comes to economic data. Signs of a slowdown in US economic output, from a high starting level, point to a further potential subsidence of inflationary pressures and ultimately interest rate cuts. This benign economic data has elicited positive reactions from equity and bond markets.
Although the inflation reading puts the US back on the path of progress it does not mean it is all plain sailing back to the 2% target. Services inflation remains too high, the majority of which is down to continued wage pressures and why signs of softening in the labour market are seen as a positive. Shelter is an area of concern, although price pressures are moving marginally in the right direction, and increasing medical services and insurance costs are also an issue. Nonetheless, although there are uncertainties, inflation is likely to continue to show an easing bias in the second half of this year and the futures market is pricing in a good probability for two interest rate cuts in 2024, all of which should be good for asset prices.
Amongst this backdrop equities made progress. The US equity market rose 1.5% in US dollar terms but much of the gain was eroded due to currency weakness as the US dollar dipped following the inflation news. In sterling terms US equities gained 0.2% taking the year-to-date return to 11.7%. The US market hit fresh all-time highs on Wednesday and remains close to that level. Large cap growth stocks were the best performing in part due to the fall in the discount rate. Information technology and real estate were the best performing sectors while more cyclical industrials, materials and consumer sectors lost ground.
The PBOC announced a significant support package to counter the economic pressure from the housing crisis and weak consumer confidence. Concurrently, the Chinese government is increasing fiscal support. China began selling the first batch of its 1trn yuan ($138 bn) special sovereign bonds, the fourth such sale in 26 years, which can be used for any purpose and are not part of the fiscal deficit.
The three previous issues have been used for bank recapitalisation, seeding the sovereign wealth fund, and COVID-19 relief. The current bond sale is expected to address the troubled property sector.
China is showing signs of a mixed economic recovery but continues to struggle with deflationary pressures. The producer price index measure of inflation fell by 2.5% year-on-year in April. Chinese equities were little changed on the week, but the Hong Kong stock market is rebounding strongly and is now up 15% year-to-date having fallen over 12% at the start of the year.
Last week saw strong performance in the metals market, with notable gains in both industrial and precious metals. Copper surged 6.6% approaching a record high, while nickel jumped over 11%. Precious metals also gained territory, with silver hitting an 11-year high rising 11.7% and gold neared its all-time peak from April rising 2.3%. The rise in copper prices positively impacted silver due to its industrial uses. Both industrial and precious metals have risen this year due to increased investor interest and a supportive macroeconomic environment coupled with tightening supply in various markets.
The Week ahead
Wednesday: UK inflation
Our thoughts: There has been solid disinflationary progress in the UK so far this year and this is expected to accelerate in April. In fact, headline inflation is anticipated to fall to 2.1%; a sliver above the Bank of England’s 2% target. This sizable drop is in large part due to the fall in household energy costs, but the pace of price rises in other areas is expected to slow too.
Sticky services inflation is predicted to drop from 6% in March to 5.4% in April helped by a more friendly year-on-year comparison – a large price increase from the year prior is due to drop off the 12-month calculation. Services inflation, due in large part to wage pressures, remains hot and this was evidenced last week when weekly earnings growth came in well ahead of forecasts at 5.7%.
Nonetheless such progress on inflation would likely pave the way for an interest rate cut in the coming months with the first priced into swap markets for August.
Friday: Japanese inflation
Our thoughts: This is expected to slow from 2.7% in March to 2.4% in April. Unlike in other regions, in Japan the current inflationary surge is seen as a positive as the country has struggled to generate a healthy rate of price appreciation for years.
Subsequently, the BoJ has recently been able to begin to back away from their ultra-loose monetary policies of negative interest rates and yield curve control having abandoned seven years of negative interest rates in March. Last week the BoJ reduced their bond purchasing programmes in the next move towards policy normalisation.
The anticipated drop in inflation in April, along with the weak economic growth for the first quarter, is not likely to be enough to waver policymakers’ determination to normalise policy and a rebound in inflation is expected in May. The swap market is pricing in two hikes for 2024, the first in September and a second in October.
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