It has been a busy fortnight with the economic data, and market mood dominated by the US inflation data
Given the previous three months had surprised to the upside, the latest release on Wednesday of this week was seen as an important signal for how long the Federal Reserve would have to maintain rates at their current levels to drive inflation towards target.
The CPI numbers were in line with expectations, and this allowed equities and bonds to breathe a sigh of relief and both asset classes rallied on the back of the data. US CPI for April was up 0.3% month on month and up 3.4% year on year. Core inflation (which excludes food and energy) was up 3.6%. All of these figures were in line with expectations and the fact that inflation has not reaccelerated further is clearly a positive outcome, but these levels remain too high for the Federal Reserve to be cutting rates. Markets however took enough comfort in the data to increase the probability of a rate cut in September to 61%, with two rate cuts expected for the year as a whole for the first time since early last month.
The US also reported employment data with the Non-Farms payrolls data weaker than expected. The US added 175,000 jobs in April, lower than the 240,000 expected and weaker than the recent trend. Unemployment climbed to 3.9%. Some solace was taken from the average hourly earnings data that saw month on month growth at 0.2% versus 0.3% expected, marginally increasing hopes that a weaker trajectory for wage growth would allow the Federal Reserve to lower rates. Fed members continued to express the need for patience in policy decisions, with Chair Powell saying we’ll need to be patient and let restrictive policy do its work” while Vice Chair Philip Jefferson said the central bank should keep interest rates in “restrictive territory” until it has “additional evidence” that inflation is moving to its 2% target.
Elsewhere in the economic data the UK reported economic growth and employment numbers. As expected, the UK exited the shallow technical recession in the second half of 2023 with the first quarter of 2024 seeing growth of 0.6%, ahead of the expected rate of 0.4%. This was the fastest pace of quarterly growth since late 2021 and was driven by services and manufacturing while the construction sector contracted. Compared to the first quarter of 2023, GDP was up 0.2%. The employment data showed a drop in payrolls as measured by HMRC of 85,000 while the unemployment rate climbed to 4.3% from 4.2% as expected. The key data in the employment report was the wage data, which remains elevated with average earnings climbing 6.0% year on year. Bank of England Chief Economist Huw Pill reacted to the data noting the easing in the labour market as seen in the higher unemployment and lower vacancies numbers but said the labour market remained tight by historical standards. The wage data, in his view, was not consistent with the 2% inflation target being met sustainably. Pill said “it is clear that the job is not yet done – some restriction is still required and the timing and extent of any cuts in the bank rate will only be able to be assessed when we have more evidence”.
The PMI services data highlighted a shift in expectations in the US versus the Eurozone with the services PMI for the eurozone boosting the composite figure to an 11 month high. The UK Services PMI climbed to a 12 month high. Meanwhile in the US the ISM PMI services data fell into ‘contraction’ for the first time since the pandemic, save for a one off ‘blip’ in late 2022. US manufacturing has been in ‘contraction’ for 17 of the past 18 months but the weakness in the services data has highlighted a recent pattern of US data coming in weaker than expected, something that will likely trouble President Biden as he seeks to create a ‘feel good factor’ ahead of the election. The US labour market is clearly softening, and leading data points to a further softening ahead. If the all-important US consumer starts to fear job losses, this will have a notable negative impact on consumption, and also President Biden’s re-election hopes.
The Bank of England meeting saw interest rates kept on hold at 5.25% as expected, though the split within the MPC showed 2 members, including Deputy Governor Dave Ramsden, voting for a rate cut. The messaging from the Bank was generally dovish, with Governor Andrew Bailey saying rate reductions were likely “over the coming quarters” and could be “possibly more so than currently priced into market rates”. He said a rate cut at the next meeting in June was “neither ruled out nor a fait accompli”. Bailey said there had been “encouraging news” on inflation and that it would fall close to the bank’s 2% target in the next couple of months. He said “we need to see more evidence that inflation will stay low before we can cut interest rates…I’m optimistic that things are moving in the right direction”. The Bank predicted GDP to grow by 0.5% in 2024 followed by growth of 1% in 2025 and 1.25% in 2026. Inflation is expected to ease to 2% in the second quarter of 2024 before edging up to 2.6% by the second quarter of 2025 before falling back to 1.9% in 2026 and 1.6% in 2027.
President Biden has been busy this week imposing further tariffs on Chinese imports into the US. The US administration imposed additional tariffs on steel, aluminium and semiconductor imports and most notably increased the tariff on Chinese electric vehicles from 25% to 100%. The White House said that China had shown no sign of moving away from practices that are harming US interests, including rules that oblige western companies to share intellectual property and subsidies that encourage the production of products well beyond expected levels of demand. President Biden said “they’re flooding the market…it’s not competing, it’s cheating”. Interestingly, European car makers such as Volkswagen and Mercedes-Benz have pushed back on EU plans to impose similar tariffs on Chinese EV imports into the region, arguing that retaliatory tariffs by China will harm their sales in the country. The US is now seeing the Presidential candidates competing to show who can be most aggressive in targeting China and protecting US manufacturing jobs. Trump has promised a 200% tariff on Chinese EVs and a 60% tariff on all Chinese imports. China has already promised to retaliate with the foreign ministry saying it “will take all necessary measures to safeguard its legitimate rights and interests”. The size of the tariffs announced this week are not substantial overall but highlight that China-bashing is moving up the US political agenda once again as the election approaches.
Source: Columbia Threadneedle Investments as at 17.05.24
