Head of FX Strategy
Summary: The inflation vs. recession debate continues to heat for the global markets even as a sense of calm is prevailing on banking stress. This week’s inflation data out from the US did not materially change the expectations of the Fed path as sticky core pressures remained the highlight. Risks on inflation remain tilted to the upside for H2 with activity levels in China improving and commodity prices surging higher again. That makes us question whether the pricing of rate cuts for this year may be too aggressive.
This week we had a host of inflation prints out from the US, but there was not much to absorb in terms of policy implications. The March CPI report was cooler on the headline and disinflation trends were also noted on the core and supercore measures. However, the supercore measure, which is preferred by Chair Powell as well, still trends somewhere in the 4-6% range, highlighting the stickiness and showing little conviction that inflation is on the way to fall below the Fed’s 2% target.
The PPI report last night cooled both on headline and core measures, and negative M/M prints cheered markets as Fed rate cuts continue to be priced in for later in the year. However, February prints for PPI were revised higher for both the headline and core, suggesting it may be too early to put inflation fears behind.
While it is reassuring to see disinflation trends continuing, the pace has been quite muted. Meanwhile, upside risks to inflation have not gone away. Average retail gasoline prices in the US are up 8% since the end of February and crude oil prices have also trended higher since the surprise OPEC cut. Banking crisis concerns have also eased, suggesting demand concerns could come back, and also get aided by China recovery gathering steam as indicated by PMI, credit and trade data this month. Meanwhile, labor markets continue to remain tight despite some recent signs of cooling, suggesting wage pressures have room to run.
Markets are currently expecting a Goldilocks situation where inflation continues to cool and recession isn’t looking too bad either. This suggests equities can continue to trade sideways to higher and there will be little in the way down for the US dollar. But what happens when one of these assumptions take a turn for the worse?
Market expectations are currently pricing in one more rate hike from the Fed but 200bps of rate cuts in the next two years. So the risk of an inflation shock is far greater than that of a recession shock, and that is also the one which is more likely. Even if a swing higher in inflation doesn’t bring the market to price in more rate hikes in light of the financial sector risks, we believe the expectations of rate cuts this year is aggressive. So the risk/reward remains tilted towards a hawkish shift in Fed expectations, provided the bank stress does not deteriorate.
Bank earnings kick off today, and will be in focus to get a sense of how much tighter lending standards could get. We expect the deposit flight into big banks (from smaller regional banks) to offset some of the credit tightening concerns. Meanwhile, consumer and corporates are still flush with enough cash and less dependent on debt, which suggests the economy is somewhat more resilient to a credit crunch in the current cycle.
Still, even as concerns of an economic recession remain subdued, equity investors will need to stay cautious of a potential drag from the upcoming earnings season. As inflation eases, companies are losing their pricing power, but wage pressures haven’t yet eased proportionally. This means there could be revenue misses, but more concerns are still on margin pressures. FactSet estimates Q1 earnings for S&P 500 companies could decline by 6.8%, the steepest decline since Q2 2020. If this was to materialize, it will be the second consecutive quarter of negative earnings growth signalling an earnings recession. Bloomberg consensus expectations are calling for a ~8% slide in EPS for S&P500 companies with most declines coming from healthcare, materials, IT and consumer staples while energy and utilities companies are still expected to post positive earnings growth.
The Monetary Authority of Singapore, in a surprise decision, kept its policy settings unchanged at the April meeting after five rounds of tightening measures. The MAS did not change the slope, mid-point, or width of the SGD NEER policy band as it expects core inflation to ease materially by end 2023 while still noting that fresh shocks to global commodity prices could impart additional inflation pressures but they may be balanced by a sharper-than-expected downturn in advanced economies.
Unlike some of the major central banks that have paused so far, the MAS did not openly signal that more tightening could come later on. Instead, growth risks seemed to weigh more heavily for Singapore’s central bank, which was a surprise given China reopening tailwinds are now starting to magnify as well. Still, what is getting clear is that central banks are ready to pause and let the effects of tightening flow through the system, rather than facing risks of a recession.
2024: The wasted year
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
