Shaw and Partners

Attention was sharply fixed on US inflation data, with markets cautious in the lead up to Wednesday’s release, as investors were looking to see if the previous months’ upticks in inflation were just a blip and what it could mean for monetary policy. The headline Consumer Price Index (CPI) came in hotter-than-expected for March, and so the prospect of sticky inflation prompted markets to sharply adjust their Federal Reserve rate cut expectations. While the Producer Price Index (PPI) released the following session rose less-than-expected, somewhat helping to calm inflation concerns, markets are now eyeing either July or September for the first rate cut. This is a stark contrast to the 150bps of rate cuts traders had been pricing in at the beginning of the year. In response to the CPI data the 10-year Treasury note had touched its highest intraday level since November and ended the week at 4..52%.

Besides inflation, mounting tensions between Israel and Iran also weighed on sentiment, with the Cboe Volatility Index closing the week at its highest level since October. This helped boost the dollar, which already strengthened from the inflation release, seeing its best weekly performance since September 2022, up 1.7% against a basket of currencies. Gold also surged to an all-time high, notching a fourth weekly gain, while Brent crude had risen above $92 a barrel. Despite the gains in oil, the energy sector still saw a weekly loss, indeed all S&P 500 sectors experienced declines. Financials were some of the biggest laggards. This came as earnings season kicked off with big banks reporting. While better-than-expected earnings were reported, a cautious outlook from JP Morgan tempered optimism. For the week, the S&P 500 lost 1.6%, the tech-heavy Nasdaq fell 0.5% while the Dow Jones Industrial Average dropped 2.4% in its worst week in over a year.

The geopolitical tensions and the prospect of higher rates for longer in the US dampened the mood in Europe, although losses were less severe. The pan-European STOXX 600 ended 0.3% lower. The European Central Bank left its benchmark policy rate at a record high of 4%, but did signal that, provided inflation data continued to ease, a rate cut at its next meeting in June was on the cards. When asked if the uptick in US inflation would sway its policy path, President Christine Lagarde commented that the ECB was “data-dependent, not Fed-dependent”. Government bonds had ticked higher after the US inflation reading but pulled back after Thursday’s ECB meeting. Bucking the trend, the UK FTSE 100 notched a 1.1% gain, helped by weakness in sterling against the US dollar.

Japanese equity markets also saw weekly gains with the Nikkei 225 up 1.4%. Yen weakness against the US dollar continues to be closely watched, with the currency weakening below the 152 level, although this did not prompt any intervention from authorities. Hong Kong’s Hang Seng index ended little changed however on the mainland the Shanghai Composite suffered a 1.6% loss. Chinese inflation data underwhelmed, with the CPI seeing just a 0.1% annualised increase in March, while the PPI logged its eighteenth consecutive month in deflation. Adding further doubts to the economic rebound, exports and imports both saw declines to reverse gains seen in the first two months of the year.

Weekly macro highlights

US inflation rises in March

US headline CPI inflation rose 3.5% year-on-year (YoY) in March, above the 3.2% recorded in February and market expectations for a 3.4% increase. In month-on-month (MoM) terms, inflation rose 0.4%, maintaining the same pace as the previous month. Food and energy prices rose 0.1% MoM and 1.1% MoM respectively in March. Excluding these components, core CPI inflation rose 0.4% on the month, contributing to the YoY core inflation rate remaining unchanged at 3.8%. Core goods prices fell 0.2% MoM in March, driven by a 1.1% decline in used cars and trucks prices. The increase in core CPI inflation in March was therefore attributed to a 0.5% MoM rise in core services prices, reflecting 1.5% and 0.6% MoM increases in transportation and shelter prices, respectively. Markets had assigned a probability of around 50% to a Fed rate cut at its meeting on 12 June ahead of the data, which dropped to around 25% following its release.

ECB leaves rates unchanged in April

The European Central Bank (ECB) Governing Council left the deposit facility and refinancing rates unchanged, at 4.0% and 4.5% respectively, at its meeting on 11 April. The central bank noted that inflation in the eurozone continues to fall, driven by lower goods price inflation. March’s flash Harmonized Index of Consumer Prices (HICP) inflation data for the eurozone highlighted this point as core inflation fell from 3.1% year-on-year (YoY) to 2.9%, driven by a decline in non-energy industrial goods inflation from 1.6% YoY to 1.1%. However, services inflation, which the ECB is watching closely, was unchanged at 4% YoY for the fifth consecutive month. Still, the ECB highlighted after its meeting that wage growth, which it has also been watching closely, is gradually moderating. This is seen by the Governing Council as an important indicator that pressure on services prices is waning. Markets currently assign around an 80% probability of the ECB reducing interest rates at its next meeting on 6 June.

UK GDP rises in February

UK GDP rose 0.1% month-on-month (MoM) in February according to estimates published by the Office for National Statistics (ONS). The data was in line with market expectations but marked a slowdown from the upwardly revised 0.3% expansion in January. Nonetheless, January and February’s data compounded to a 0.4% increase over the two months. With activity indicators such as Purchasing Managers’ Indexes remaining firm in March, it is likely the UK economy expanded in Q1, and that the technical recession therefore ended in Q4 2023. Growth in February reflected a 0.1% MoM expansion in services output and a 1.1% MoM increase in production output. These increases offset a 1.9% MoM decline in construction output. According to the ONS’ monthly estimates, GDP in the UK is now 2% above its pre-pandemic level in February 2020. In year-on-year terms, UK GDP fell 0.2% in February, above market expectations for a 0.4% decline.