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17 April, 2023 - We can stop worrying about inflation (for now).



March inflation data in the US showed a remarkable slowdown last week, giving rise to optimism that the FED will soon stop increasing interest rates. Then again, given the recent macroeconomic data as well as the mini banking crisis, one should not have expected something different. The bond market is already discounting interest rate cuts before the end of the year, based on the premise of a recession approaching in the next few months. For now, we all welcome the fall in inflation, which reduces one significant obstacle to the central banks to act if necessary, if and when the economy stops growing. At the same time, inflation is coming down for specific reasons, one of them being the base effect which we have described several times, but the most serious one is the drop in demand for goods and services. Therefore, we cannot be over-excited and chose to remain defensive.


The March headline CPI rose just 0.1% on a monthly basis, lower than expected (0.2%) and down from February's 0.4%. The annualized rate fell to 5.0% and was also below consensus for 5.2%. This compares to February's 6.0%, showing a full percentage point drop in one month. However, the Core CPI rose to 5.6% up 0.1% from last month's 5.5%, which was still in-line with expectations. Looking into the details, food prices remained stable on a monthly basis, while food at home fell 0.3%, which is the first contraction since Sep-20. More importantly rents' growth slowed down to 0.6% from 0.8% last month, while medical care services were negative for a third-straight month.


The Producers Price Index (PPI) for March also dropped significantly. The monthly change was -0.5% vs expectations for a rise by 0.1% , which made the annual rate to fall to just 2.7%, down from 4.9% in the previous month. The Core PPI, which excludes food and energy dropped to 3.4%, down from 4.8% in February.


China continues to be the only major region without an inflation problem. March CPI was announced at just 0.7% annual rate, which compares to 5% in the US and 7% in the Eurozone.


The US labor market has started deteriorating, but only slightly. The March non-farm payrolls number was announced at 236'000 which was the slowest growth in the last few months, and annual wages growth moderated further to 4.2% down from 4.6%. The weekly initial jobless claims rose again, this time to 239'000 and the continuing claims spiked to more than 1.8mn, which is the highest in the last 12 months.


The minutes of the last FED meeting offered a mini surprise. It was the first time that the forecasts of the committee members showed the probability of a mild recession in the remaining 9 months of this year. Up to now the official scenario was that of just a slowdown in economic growth, with the word recession not being mentioned by J. Powell or any other voter. Things look to have changed after the recent bank failures and the tightening of financial conditions.


Equities had a volatile week but finished positive. The US broad indices finished the week with gains of 0.5%-0.8% but Dow Jones added 1.5%. Europe performed again much better with close to 2% gains and the Euro Stoxx 50 reaching a new high for this year. In terms of sectors it was the economic-sensitive (cyclical) ones which did better, with Financials, Materials and Energy posting gains of almost 3%, something which does not comply with the weak macroeconomic data of the week.


Bonds lost ground on the last day of the week. In a bizzare last few hours of trading and after weak macro-economic data, bond prices started falling significantly (and yields rising), with no real explanation. Perhaps the better-than-expected results by the major US banks made investors take profits on bonds, which had rallied after the outbreak of the mini banking crisis in mid-March. Another explanation were comments by ECB officials who mentioned that the central bank might have to start reducing its balance sheet more aggressively than previously thought. The US 2-year yield rose to 4.10%, up from around 3.90% where it was trading for most of the week, while the 10-year rose to 3.50%.


Gold is attempting for the third time a trip above 2000$. Helped by the weakness in USD as well as aggressive central bank buying, the yellow metal finished the week above 2000$, despite the sell-off on Friday. During the week, Gold had touched 2050$, but the late-Friday spike in yields soon spilled to all asset classes, including pecious metals.


The Q1 earnings season has started with large US banks posting much better than expected numbers. JP Morgan, Wells Fargo and Citibank posted solid revenues and profits, while forecasting better than expected numbers for the full year too. Of course the effect of the recent regional bank failures was not felt during the previous quarter as this happened in mid-March, with only two weeks remaining for the calculation of their numbers. Still, their full year forecast sounds a bell of optimism. It seems that despite the higher cost of their deposits , the fact that they must have accumulated cash from smaller banks appears to offset this drag on profitability.

 

Chart of the Week : US inflation is moving rapidly lower.



The chart by UBS shows the annual inflation rate in the US , for the last 8 years and the bank's projection ( dotted lines) for the next two years. The light blue line is the headline CPI number and the black line is the core CPI, which excludes food and energy. As one can see in the light blue line's trajectory, the fall is rapid after the peak of last June and is roughly equal to the rise in 2021-2022. This fall can be attributed to a great extent to the startistical notion of "base effect" of which we have been writing frequently since last summer. The fact that inflation is simply a mathematical ratio (a division) between the price levels of the same month in two different years means that prices do not have to fall for inflation to move lower, they just have to stay stable or grow very little. Inflation could fall to around 3% by the end of the year, according to this graph. Another observation that can be made is that the core CPI (black line) is much stickier and does not seem to be falling at the same rate. The main reason is that some items in it and primarily rents and housing related costs have been rising at a fast annual rate, even until recently. But this is also about to change, as according to the latest data house prices have been falling and rents usually follow.


Disclaimer

• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

• Sources: Chart of the Week : UBS Research


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