The US CPI increased by 3.4% year-on-year in April (previous value of 3.5%), and the core CPI increased by 3.6% year-on-year (previous value of 3.8%), both of which slowed down from the previous month, in line with market expectations. From the perspective of sub-items, the prices of second-hand cars, furniture and household appliances continued to fall, and service inflation remained sticky. This set of inflation data is significant for the market, it reduces "secondary inflation" fears, helps to improve risk appetite, and drives US stocks higher. But we don't think a month's worth of data will make the Fed move to rate cuts anytime soon, but rather that slowing inflation will make financial conditions more accommodative, the economy and inflation will be more resilient in the future, and the likelihood of a "no-landing" will rise, as has happened in the past few months. We reiterate our previous view: the more the market wants to cut interest rates, the looser financial conditions will be, and the more difficult it will be to cut interest rates in the end, and the Fed may cut interest rates only once this year, either in the fourth quarter (please refer to the "Lowering Fed Rate Cut Forecasts"). Treasury yields will remain high for longer, and U.S. equities may continue to be more attractive than bonds.
After three consecutive months of larger-than-expected gains, U.S. inflation data slowed for the first time in April, in line with market expectations. From the perspective of sub-items, the decline in commodity prices is the main "ballast stone". Prices of household food (-0.2%), new cars (-0.4%), used cars (-1.4%), and furniture and home appliances (-0.4%) continued to fall, benefiting from supply chain improvements on the one hand, and on the other hand, due to the structural shift of consumer demand from goods to services after the epidemic.
Services inflation remained resilient, with 3.1 percentage points of the 3.4% year-on-year CPI growth coming from core services. Among them, one of the indicators that the Fed and the market pay the most attention to, non-rent core services inflation (supercore) has eased to some extent. The seasonally adjusted month-on-month growth rate of the indicator fell from 0.6% to 0.4%, the lowest since the beginning of the year, and the three-month month-on-month annualized growth rate fell to 6.3% from 8.2% in the previous month. Rent inflation was unchanged from the previous month, and the seasonally adjusted month-on-month growth rate remained at 0.4%, although hotel prices fell by 0.3% month-on-month.
This set of inflation data is significant for the market, as it reduces "secondary inflation" concerns and helps to boost risk appetite. As U.S. inflation data has risen more than expected for three consecutive months since the beginning of the year, the market is worried that this will trigger further interest rate hikes by the Federal Reserve. Although Fed Chair Jerome Powell said after the May FOMC meeting that he would not consider the option of raising interest rates for the time being[1], the market still hopes for a set of real data to support Powell's view. Today's inflation data provided a "reassurance" to the market, which also pushed US stocks to soar, with the S&P 500 index standing above 5,300 points, hitting another all-time high. U.S. Treasury yields fell, the dollar weakened, bitcoin, gold and crude oil rose, and risk appetite improved significantly.
Will slowing inflation make the Fed pivot to rate cuts? We don't think it's going to be a good idea to do that with a month's worth April's inflation data did not rise more than expected for the first time this year, and its seasonally adjusted month-on-month growth rate fell for the first time in the past six months. Fed officials have previously said that there is no rush to cut rates at the moment, but that they need more time to gain confidence in cutting rates[2]. April's inflation data helped somewhat, but it wasn't enough, and we think we need to see at least 2-3 months of slowdown in inflation data for the Fed to restart its guidance on rate cuts.
What's more, the slowdown in inflation has made financial conditions more accommodative, which in turn has pushed back the timing of rate cuts. We have previously put forward the idea that the Fed and the market want to cut interest rates the more they want to cut them, the more they will actually not be able to cut them. This is because the expectation of an interest rate cut will lead to loose financial conditions, which in turn will make the economy more resilient to inflation, and ultimately make it difficult to achieve a rate cut. This phenomenon has already happened in the past few months: in the fourth quarter of last year, the Fed gave premature guidance on interest rate cuts, and the market expected that the Fed would cut interest rates soon, which led to a broad rise in US asset prices, with stocks, real estate, bitcoin, and gold prices all hitting record highs, and a significant improvement in the net worth of the household sector, resulting in a strong wealth effect. At the same time, corporate credit spreads have narrowed, financing costs have fallen, refinancing pressures have eased, and economic and employment resilience has been strengthened (see Fed's 'dovish preference' increases the risk of non-landing). After the release of the inflation data, the market showed a strong risk-on sentiment, and US stocks hit new highs again, indicating that financial conditions continue to ease. We believe this will increase the resilience of the economy in the future and increase the likelihood of a "no-landing", as has happened in the past few months.
We reiterate our previous judgment that the Fed may only cut interest rates once this year, either in the fourth quarter (please refer to the "Downward Revision of Fed Rate Cut Forecasts"). Fed Chairman Jerome Powell said after the May FOMC meeting that there are two scenarios for the Fed to cut interest rates: the first is that inflation continues to cool and moves closer to the 2% target; The second is a larger-than-expected deterioration in the labor market, such as a significant increase in unemployment. At the moment, both scenarios are premature, so we maintain our judgment that we will only cut rates once this year. In our view, the implication for the market is that US interest rates will continue to remain high for longer, but equities are likely to remain more attractive than bonds as the economy is resilient and corporate earnings are supported.
Chart: US CPI inflation data for April slowed for the first time since the start of the year
Source: Wind, Haver, CICC Research
Chart: Core services contributed 3.1 percentage points to headline CPI inflation
Source: Haver, CICC Research
Chart: Non-Rent Core Services Inflation Eases to 0.4% MoM
Source: Wind, CICC Research
Chart: U.S. Treasuries fell, with the S&P 500 hitting all-time highs
Source: Wind, CICC Research
Dr. Liu Zhengning also contributed to this article.
[1]https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20240501.pdf
[2]https://www.nytimes.com/2024/05/09/business/economy/federal-reserve-powell-raise-interest-rates.html
Article source:
This article is excerpted from, "Slowing Inflation Makes Financial Conditions More Accommodative", published on May 16, 2024
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