The most talked about topic over the last couple of weeks has been the resurgence in US inflation and its effects on rate cut expectations.
The year began with expectations that the Federal Reserve may have to cut rates between six or seven times. Since then, rate cut expectations have moderated substantially as inflation has not reached the Federal Reserve’s 2% target. In fact, markets are now pricing in between one to two rate cuts of 25bp each by year-end. Besides the recent US inflation print, the strength of the US labour market has also contributed to the lowering of rate cut expectations.
US non-farm payrolls released on April 5 came in at 303,000, above expectations of 200,000. The print was also above the prior data point of 270,000. Furthermore, the unemployment rate came in at 3.8%, below consensus and the prior rate of 3.9%.
Unlike the European economy… the US economy remains resilient as economists are now pencilling in higher economic growth
While the market had begun to adjust rate cut expectations following the publication of the better-than-expected labour data, rate cut expectations decreased once inflation data was released on April 10. Inflation prints showed that, on a year-on-year basis, inflation in the US has increased to 3.5%, above expectations of 3.4% and the prior rate of 3.2%. Core inflation, on a year-on-year basis, came in at 3.8%, above expectations of 3.70% but in-line with the prior print.
The Federal Reserve’s preferred measure for inflation is the Personal Consumption Expenditures Price Index, with the March data set to be released on April 26. However, the inflation print released earlier this month, together with the labour data, signified a notable shift in the Federal Reserve’s fight against inflation. Unlike the European economy and prior expectations that the US economy was perhaps heading for a so-called “soft landing”, the US economy remains resilient as economists are now pencilling in higher economic growth.
On the other side of the Atlantic, the macroeconomic picture and expectations around rate cuts is somewhat different. The rate of inflation for the euro area declined to 2.4% year-on-year in March and came in lower than expectations and the prior month’s data of 2.6%. Core inflation declined for the eighth straight month in March to 2.9%, the lowest since February 2022, and came in lower than both expectations and the prior month’s figure of 3.0% and 3.1% respectively.
Furthermore, the European Central Bank’s Governing Council delivered a dovish message at its meeting held on April 11 and noted that it would consider cutting interest rates at its next meeting in June, with the market now pricing in three possible rate cuts of 25bp each by year-end, which has remained unchanged since the start of the year, unlike the change in expectations of Federal Reserve rate cuts since January.
Financial markets have reacted to the latest data points, particularly the US data points, and lower rate cut expectations accordingly, as sovereign yields have risen. In fact, the yield on the US 10-year has risen by 43bp to its current 4.6% (as at time of writing) since the start of April, following the release of US inflation data, and experienced its sixth largest one-day increase since 2017.
Other sovereign benchmark yields, such as the German 10-year and the UK 10-year, have also risen following the strong US economic numbers. But the contrast is evident, with the German 10-year rising by only circa 14bp to its current 2.4% (at the time of writing) while the UK 10-year has risen circa 38bp to its current 4.3% (at the time of writing) since the beginning of April.
Going forward, the focus on inflation and rate cuts will remain front and centre. While the upcoming inflation prints will remain key to understanding the potential path of future interest rate decisions, the Federal Reserve’s FOMC meeting set to be held at the beginning of next month will play a particular role in the near-term as the market will be attentive to the language and view on inflation and its potential rate path.
Simon Gauci Borda is a research analyst with Curmi and Partners Ltd.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.