The inflation puzzle

Thank God! Yesterday’s inflation report from the US wasn’t worse than expected. The core PCE index showed that, yes, the monthly inflation rose at the highest pace in a year, but that the yearly figure eased from 2.9% to 2.8%. Both figures matched market expectations. As such, yesterday’s data hinted at inflation uptick in January, but the data came as a relief for those who were prepared for the worst. A soft jobless claims figure also helped cooling the hawkish Fed worries. That’s why the S&P500, Nasdaq and Russell 2000 rebounded yesterday.

But the US dollar rebounded, as well, following the PCE print. The services inflation – which excludes housing and energy prices - jumped 0.6% on the month, the highest since March 2022. And US Labor Department sent a group of ‘super data’ users an email saying that the surge in last month’s inflation was due to a shift in underlying calculations, and not necessarily due to the rise in prices. The BLS tried to unsend the email, but you can’t fool the ‘super data’ users, can you? The information was seen, and some of them think that if what they saw is correct, the US rent inflation could remain elevated for a few more months, and that should keep the Federal Reserve (Fed) doves at bay.

Still, the stock markets reacted positively to the latest PCE data, and the US yields eased posterior to yesterday’s PCE data and to the news that BLS is cooking something unusual in its kitchen. The probability given to a June rate cut settled at around 67%.

In Europe, the inflation heatmap was mixed. Inflation in Germany slowed more than expected, Spanish and French figures were slightly higher than expected, but still, French inflation fell to the weakest level since September 2021. Combined with the weak economic outlook in the region, the latest inflation prints revived the expectations that the European Central Bank (ECB) could start cutting its rates before the Fed. The EURUSD slipped below the 100 and 200-DMA, fundamentals back a further depreciation of the euro against the greenback provided the diverging strength of the underlying economies – which by the way is not only due to the fact that the Americans are so strong that they can defy whatever rate hikes the Fed throws at them, but it’s partly because the US government spends at a furious speed, whereas the euro-area economies have a better budget discipline! But whatever it is, the US economy is doing significantly better than the Eurozone’s. That’s why the ECB is expected to cut more than the Fed this year. Although not many see the ECB start cutting rates before the Fed.

In Japan, the policymakers are not in a hurry to hike their rates. A Bank of Japan (BoJ) board member’s words that the BoJ could be approaching the end of the negative rates had sent the USDJPY below the 150 level earlier this week along with a stronger than expected BoJ core PCE report, remember? Well, the Governor Ueda came to spoil the BoJ hawks’ trade by saying that their price target is not yet in sight, and that they will ‘continue to seek confirmation whether the virtuous cycle between wages and price began to turn’. The USDJPY is back above the 150, but can probably not go further up because traders fear a direct FX intervention from the Japanese authorities to prevent the yen from losing too much value. Nikkei 225 hit a fresh record.

Elsewhere, the Chinese PMI figures came in slightly better than expected in February but the manufacturing activity shrank for the 5th straight month and home sales slumped faster despite stimulus measures to throw a floor under China’s falling property market. In numbers, the value of new home sales from the 100 top developers have reportedly slipped by 60% from a year earlier! The latter home data comes as yet another proof that a property crisis has no easy, overnight fix. It took Japan three decades to get out of deflation. But good news is that the Chinese equities are consolidating and extending gains this week. The CSI 300 index recovered to the highest levels in three months.

While China is struggling with a worsening property crisis, aging population and deflation, India posted a 8.4% growth in Q4, higher than analyst expectations. A part of the GDP growth may come from a surge in taxes, but overall the Indian government predicts that the EM giant will reach a whopping 7.6% through the fiscal year to March, higher than 7.3% they predicted earlier. The Indian Nifty 50’s outperformance compared to the Chinese CSI is indisputable since mid-2021. If China can’t remedy to its home crisis, India could finally become the new China.