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• Japanese equities rallied in sterling terms, rising c. +2.6%
• Equities also edged c. +1% higher in the UK, Asia and emerging markets

• Equities declined c. -1% in Europe
• Bonds also broadly declined, with European govvies down c. 1% and UK gilts down -0.3%

Rate expectations shifted significantly last week, in the wake of a strong US inflation print. In March, headline CPI accelerated to 3.5% year-on-year, up from 3.2% and ahead of consensus (3.4%), while core CPI remained at 3.8%, ahead of consensus (3.7%). Within the print, food (14% of the basket) accelerated to 0.1% from 0.02%, along with medical care, furnishings, other goods & services and apparel. This was partly offset by a deceleration in shelter (34% of the basket), transport and autos, services, recreation, fuel & utilities, communications, education and tobacco.

The March print follows a number of beats year-to-date, and the stronger-than-expected report led market participants to reprice the likelihood of rate cuts, from three starting in June or July to two starting in September or November.

This repricing is in contrast with the Fed’s own sanguine view of economic data. At the March FOMC meeting, Chair Powell brushed off concerns about stronger CPI prints as “bumps in the road” - confirming that the inflation “story is really essentially the same.” He also maintained his confidence measures of rents and rent-proxies should decline, and that the labour market was easing.

The question now is for how long the Fed maintains confidence in the economy slowing, if inflation remains stronger than expected. Key factors to watch will be the labour market revisions and how owner equivalent rent calculations evolve. Given the large basket weight of shelter, a decline in imputed rental costs, which is expected given where market prices are, could have a strong cooling effect on CPI.

It is also worth remembering that it is Personal Consumption Expenditures Index (PCE) rather than CPI that is the Fed’s official target and that, despite recent strength in CPI, PCE is still expected to cool in coming months.

While we still expect some cuts this year, this recent resilience is a reminder that the Fed may wait longer to deliver rate cuts. Nonetheless, with current policy relatively restrictive, the Fed can cut rates without making policy accommodative.

Against a backdrop of softer data, the European Central Bank left rates unchanged at the April meeting, but tweaked guidance. While markets had seen April as a “live” meeting, Lagarde dismissed this in March, pointing to the fact that “much more” would be known in June.

While there were no changes to policy at the April meeting, the wording of the statement was changed. Instead of saying that rates need to remain at current levels for a considerable time to bring inflation under control, the statement now confirms that “interest rates are at levels that are making a substantial contribution” to bringing down inflation. The statement also says that “if the Governing Council’s updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission were to further increase its confidence that inflation is converging to the target in a sustained manner, it would be appropriate to reduce the current level of monetary policy restriction”. Futures pricing suggests the market expects a first cut in June or July, with a second in September and a third in December.

At the end of last week, China’s State Council revealed a new set of guidelines for how capital markets in China will develop.

This is the third “nine-point plan”, following announcements in 2004 and 2014. The first plan related to the development of the capital market, and paved the way for the boom in ‘A-shares’ (securities of companies incorporated in mainland China and trading in Yuan) between 2005 and 2007. The second review addressed registration-based stock issuance, private funds, and the professionalisation of the sector, streamlining the IPO process and connecting China’s market to the global market.

The focus of the third review is on the quality of listed companies, treatment of shareholders, and execution mechanisms. Enhancing these aspects of the ‘A share’ market would go some way to further deepening access to international capital markets and the index rallied following the news.

While the nine-point plan was a boost to markets, economic data continues to show weakness. Trade data pointed to continued softness in exports, which fell 7.5%, while imports were down 1.9%. Admittedly, 2023 provided a tough comparison to beat, with the reopening of China’s economy from pandemic restrictions leading to a surge in activity and a 10% rise in exports. However, while phone and PC exports held up, consumption exports were softer. Imports were also soft for energy related commodities, while other commodities were more resilient.

Credit data also disappointed – loan growth was weaker-than-expected, with total loans at RMB 3,090bn (c. $433m) and growth slowing to 9.6%. While total social financing strengthened to RMB 4,873bn, growth slowed to 8.7%. M2 (a measure of a nation’s money supply) also slowed, decelerating to 8.3%.

Lastly, inflation data also slowed. March CPI softened to 0.1% year-on-year, from 0.7%, while producer price inflation remained negative at -2.8%. Combined with soft activity data, this makes deflation a serious danger for China’s economy. Without further policy support, Beijing’s 5% GDP growth target doesn’t look achievable and, combined with low or negative inflation, this could translate to very low nominal growth, and therefore very low corporate earnings growth.

 

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