Source: Kevin Strategy Research
Authors: Liu Gang, Li Yujie, Wang Zilin
The third quarter was the main window for inflation to fall back and policy adjustments. The current inflation data fell short of expectations and ostensibly raised expectations of interest rate cuts, but it is probably not a “good thing” too early.
On the evening of May 15, the US released April inflation data. The overall CPI was significantly lower than market expectations, but it was basically in line with our forecast, while the core CPI was the same as market expectations, but lower than our forecast. After the data was released, the overall reaction of the market was positive. Interest rates on US bonds declined, US stocks rebounded, the US dollar weakened, and gold strengthened. Expectations of interest rate cuts implicit in CME interest rate futures in the market are also heating up again, and the probability of interest rate cuts in September rose to 88%.
Non-agricultural and CPI fell short of expectations one after another in April, in stark contrast to market concerns about secondary inflation or even another rate hike after successive exceeding expectations a month ago. So, how do you understand that the current inflation data, as well as the recently released April PMI, non-agricultural data, etc. fell short of expectations? Our review is as follows:
The main reason that fell short of market expectations was overall inflation. Core inflation was basically in line with market expectations. Overall inflation benefited from falling food and gas prices.
The overall CPI for April was 0.31% month-on-month and 3.36% year-on-year, basically in line with our forecast (0.32% month-on-month, 3.36% year-on-year), lower than market expectations (0.4% month-on-month, 3.4% year-on-year), and fell significantly from previous values (0.38% month-on-month, 3.48% year-on-year).
The core CPI was 0.29% month-on-month and 3.61% year-on-year, lower than our forecast (0.36% month-on-month, 3.68% year-on-year), basically in line with market expectations (0.3% month-on-month, 3.6% year-on-year), and also declined significantly from previous values (0.36% month-on-month, 3.80% year-on-year).
By category, the overall CPI was mainly due to falling food (-0.20%) and gas (-2.86% month-on-month) prices.
In the core CPI, the rent segment declined rapidly (0.35% vs. previous value 0.41%), equivalent rent fell slightly month-on-month (0.42% vs. previous value 0.44%), medical services 0.45% month-on-month (previous value 0.56%), and auto insurance, which clearly disrupted the market last month, also declined slightly by 1.76% month-on-month (previous value 2.58%).
Why did the recent “pile up” of data weaken and fall short of expectations, while the “push” surpassed expectations a month ago? This is due to tight financial conditions.
The April inflation data is another weak figure after April's PMI and non-agricultural production, and retail consumption released tonight was also lower than expected. This is not surprising or “mysterious”. Due to tight financial conditions, the effects of rising interest rates some time ago began to have an effect on demand and prices.
Interest rates fell at the end of October last year and loosened financial conditions drove demand improvement. As a result, US economic data such as employment, inflation, and PMI continued to exceed expectations at the beginning of this year. Coupled with the sharp rise in commodity prices during the same period, not only led to a decline in interest rate cuts, but even in the face of concerns about secondary inflation, voices of interest rate hikes reappeared.
However, in April, higher interest rates gradually became counterproductive. In March, data such as existing home sales, manufacturing PMI, non-agricultural, and retail consumption slowed down one after another, and expectations of interest rate cuts rose again to two times during the year (September and December).
This phenomenon of data “pushing” and swinging back and forth in both directions exceeding expectations is actually not surprising; it is exactly the opposite of the tight financial conditions we emphasized.
After the data was released, market risk appetite increased, but there are also certain concerns behind the rise in risk appetite, mainly because:
1) What is lower than market expectations is overall inflation, and the core inflation that is more concerned is basically in line with market expectations. Coupled with the May 14 PPI data exceeding expectations, this combination is not entirely ideal.
2) The current decline in interest rates, the rebound in US stocks, and the massive rise have once again loosened financial conditions over the past month, where expectations of interest rate hikes were postponed and slightly tightened due to higher interest rates.
If things continue like this, after a month or two, we may once again see an increase in the probability that the data exceeds expectations due to the reversal of financial conditions, and at the same time weaken efforts to control inflation (for example, the possible factors that anchor interest rates on 10-year US bonds have declined again, causing a resurgence in production demand).
This “back-and-forth” will, in turn, delay expectations of interest rate cuts, suppress the market, and become a copy of the market's excessive and premature expectations of interest rate cuts at the beginning of the year. Therefore, we are worried that this kind of rebound and excitement may not last long.
The third quarter was the main window for inflation to fall back and policy adjustments. The current inflation data fell short of expectations and ostensibly raised expectations of interest rate cuts, but it is probably not a “good thing” too early.
Judging from this year's market pace, the window for policy adjustments and weakening inflation is mainly concentrated in the third quarter, mainly because inflation in the fourth quarter may be slightly delayed, while general election factors also interfered in the fourth quarter.
In this context, if the interest rate cut transaction starts too early, it may cause inflation to fall less than expected in the third quarter, causing the interest rate cut window for the third quarter to be missed. If this window is missed, the fourth quarter will face a general election and the end of the year's inflation. Instead, it will be more troublesome to start cutting interest rates during the year.
In this sense, we are concerned about the room and sustainability of rising market and asset risk appetite in this position. In other words, even if you participate, pay attention to the continuation of the rebound and the reversal of interest rates.
As far as the Federal Reserve is concerned, it may learn the lessons of a rapid shift at the end of last year, which led to higher inflation at the beginning of the year, and wait for more data to be implemented (for example, inflation continues to fall next month) and then relax.
Editor/Jeffy