The first half of last week was dominated by Tuesday’s stronger than expected US CPI (Consumer Prices Index) print, which sent stocks and bonds tumbling from their recent highs. This was followed by a swift turnaround after some softer data soothed traders' and investors' worries, before the S&P 500 Index rallied to end the week on a new high.
Admittedly, January’s CPI and PPI (Producer Prices Index) data was disappointing. We do not feel, however, that this signals a return to higher inflation. Yes, the headline US CPI figure came in at 3.1% year-on-year. And yes, this is 0.2% higher than what was expected. But it is still noticeably lower than December’s 3.4%. If there are concerns, they are about the core inflation rate (excluding food and energy). This is stickier than anticipated: 3.9% year-on-year (slightly higher than the expected 3.7%).
There is also the “January effect” to consider when looking at these readings. Major corporations tend to push through price increases at the start of the year. This can then have a disproportionate impact on January’s inflation data. It might just be a one-off effect, as opposed to a trend that will characterise the year head. If this is temporary, then there should be further moderation in the coming months – particularly regarding goods prices.
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Those who believe that US inflation may persist over the coming months may well cite a strong economy and resilient consumers as inflationary pressures. It is indeed true that over the past four quarters, the US economy has grown at an average annualised rate of 3.1% – significantly above trend growth of 1.5% to 2%. Strong household consumption has been driving its growth.
Post-pandemic, consumers have all significantly changed their consumption patterns: instead of buying goods online, they are buying services and experiences – and that includes travel, leisure, hospitality and dining out. This has also shown up in higher services inflation and softer goods inflation in both CPI and PPI baskets. But can US consumers maintain their spending at this level?
There may already be some early signs that consumers are reining in their spending. This past week, the monthly US retail sales figures for January came in significantly below expectations: they fell 0.8% month-on-month. This was more than the expected 0.15% decline and below December’s 0.4% gain. This is a trend that is worth monitoring closely: monthly retail sales figures can be volatile. These figures tend to track goods consumption versus services consumption, which we know can be a lagging indicator.
While there are few noticeable cracks in consumption (and the US consumer is notoriously difficult to bet against), we may see some cooling in the labour market as the year unfolds. This could put some downward pressure on wage gains and services inflation.
According to the Fed’s own predictions, the US unemployment rate will rise to 4.1% from its current 3.7%. And leading indicators – such as job openings and resignation rates – have already moved lower. We are not expecting a deep or prolonged labour market slump in the US. Better supply and demand ratios may help temper wage gains and soften consumption, and this will support further falls in the rate of inflation.
The world’s primary concern remains ongoing conflict in the Middle East. Shipping costs have already spiked up, and some companies have cited supply chain worries in their corporate earnings forward guidance statements.
But this all needs to be kept in perspective.
Disruptions in the Red Sea simply make trade more difficult: container ships can go around the Cape of Good Hope as an alternative to the Suez Canal. This is a long way from the complete stop that we saw during the pandemic. So shipping costs have indeed spiked, but they are still more than 60% lower than their 2020 highs.
Another highly relevant statistic is that only 4% of the cargo that travels through the Suez Canal is bound for the US, compared with 40% for Europe and 30% for Asia. The Red Sea attacks will therefore have less effect on domestic inflation stateside than in the Eurozone or Asia-Pacific region.
In the UK, news that the economy fell into a technical recession in the second half of last year did not come as a real surprise. As higher interest rates have taken their toll and forced households to cut back on their spending, the market is perhaps now more disappointed than shocked.
There was some positive news: retail sales in the UK surged in January, beating market expectations.
The UK’s annual CPI inflation rate remained unchanged at 4% in January. This was lower than the 4.2% that the market had been expecting. Governor of the Bank of England Andrew Bailey indicated that while this data was “encouraging”, it did not mean there would be interest rate cuts any time soon. In fact, the markets are now forecasting the first rate cut to be in June, rather than March.
On the political front, the Labour Party decisively won two by-elections, overturning sizeable Tory majorities in Wellingborough and Kingswood. There is now much riding on the UK spring budget next month, with Chancellor Jeremy Hunt extremely keen to paint a positive picture for the UK economy. He will doubtless seek to offer something to the electorate before the country heads to the polls later this year. Personal taxes and the savings regime could well be an area he focuses on.
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Meanwhile, the European Commission has cut its forecast for Eurozone growth in 2024. The revision downwards now reflects the inflation backdrop, which has eroded people's purchasing power, and higher interest rates, which have curbed credit. The Commission does, however, believe that growth will then accelerate in 2025.
In Asia, Japan’s Nikkei 225 and TOPIX indices have continued to rise and are now at 34-year highs. Yen weakness and positive corporate earnings releases lent support to the market. Disappointingly, however, Japan’s economy contracted quarter-on-quarter over the final three months of last year: it has now dropped from third to fourth position in GDP terms – just behind Germany.
China continues to struggle – it is one of the only countries in the world grappling with deflation, and a year-long property sector crisis has dampened consumer confidence. Its stock market has been closed for the Lunar New Year celebrations, but reopens this week.
Once again, we do expect inflation to moderate further. But given ongoing uncertainties in the Middle East and Eastern Europe, the path it takes is likely to be anything other than a straight one. This will likely generate even more volatility for stock markets. But for investors, this could also mean some excellent opportunities – particularly for those who were not able to fully leverage the rapid rally that began back in October 2022 and carried through to late last year.
Pullbacks are likely and even expected. But given the fundamental backdrop, we do not see any corrections evolving into a vicious bear market. We would therefore suggest using any market weakness and volatility as an opportunity to accumulate quality assets ahead of a potential multi-year rate-cutting cycle that the Fed might initiate mid-year, which could push the markets even higher.
