US inflation has come in hot for the third consecutive month, reducing market enthusiasm for policy rate reductions.
The March US CPI printed above expectations at 0.4 per cent, taking the annual pace to 3.8 per cent.
Equities sharply declined and the US dollar jumped higher while US Treasury yields surged higher across the curve.
Reacting to inflation’s consecutive upside surprise, AMP’s Shane Oliver declared a June rate cut unlikely.
“This is a concern and along with strong US economic data will keep the Fed cautious and – absent much slower jobs and inflation data ahead – means that a June cut is now unlikely and expectations for the start of rate cuts being pushed back to around September,” Oliver said.
“This, in turn, will likely mean a rougher near-term ride for share markets which had run ahead of themselves so far this year.”
At the beginning of the year, the bond market had anticipated approximately 175 basis points (bps) of policy rate cuts, equivalent to seven separate 25 bp cuts. This would have necessitated initiating cuts in March.
However, persistent inflation and a robust labour market significantly dampened this optimism. Leading up to the release of the March CPI, the expectation had dwindled to three policy rate reductions for the calendar year.
This has now reduced to between one and two Fed rate cuts this year – a prediction GSFM investment strategist Stephen Miller considers overly optimistic.
“Since the commencement of the policy tightening process in early 2022, markets have exhibited an ongoing predilection to ‘false start’ on rate cuts based on an overly optimistic assessment of the rapidity with which inflation might decline or an overly pessimistic assessment of the resilience of activity growth and the labour market. That is despite a litany of disappointments on inflation,” Miller said.
“In the post-pandemic period, the aftermath of inflation reads has generally led to an eerily familiar revisitation of rate cut expectations as markets temper their policy rate cut expectations. This brings to mind the film Groundhog Day where events repeatedly unfold in a way that has happened before.”
He believes that this time around, it may be necessary for both the market and the Fed to reassess the expected magnitude of any potential policy rate reduction, if indeed there is one, within this calendar year.
For him, the March CPI serves as a reminder that the process of disinflation tends to be more disjointed – a process of “two steps forward and one step back” with the “last mile” to the inflation target proving particularly challenging.
Global message misaligned
According to Oliver, the message globally is not all in alignment with the Fed, with inflation in Canada and Europe falling faster than expected. As such, the economist believes both the Bank of Canada and the European Central Bank look on track to start cutting rates around mid-year.
Miller agrees that a rate cut in Europe is imminent.
“The inflation data supports expectations the European Central Bank will cut policy rates in coming months,” he said.
The US experience is, however, expected to concern the Reserve Bank of Australia.
In fact, traders now believe an easing is unlikely until December, pricing in just 22 basis points of cuts by the end of the year.
Oliver, too, believes US CPI data increases the risk that rate cuts in Australia are delayed.
“Ultimately, this could be overruled by local inflation continuing to fall faster than expected, but the risks of RBA rate cuts coming later rather than sooner have increased,” Oliver said.
While June is still his base case, Oliver admitted August or September now look “more likely”.
“Ultimately, it will come down to what our CPI data does.”
CPI in Australia rose 3.4 per cent in the 12 months to February 2024, coming in below market forecasts for a 3.5 per cent rise.
Previous market consensus was that the ECB would be the first cab off the rank in terms of rate cuts, commencing in June or July, followed by the Fed in late July, and the RBA in early August.
