Inflation Uptick Dampens US Rate Cut Outlook

For the week ending 16 February 2024

As of midday Friday, global equities were modestly higher on the week despite a surge in US inflation readings and dwindling anticipation of rapid rate cuts from the US Federal Reserve. The yield on the benchmark US 10-year Treasury note continued its sharp rise, jumping to 4.31% from 4.16% a week ago. The price of a barrel of West Texas Intermediate Crude oil added to recent gains, reaching $77.50. Volatility, as measured by the Cboe Volatility Index (VIX), rose to 14.4 from 12.9 last Friday. 

MACRO NEWS

January inflation rise upends US rate bets

Investors pared back expectations of near-term Fed rate cuts after consumer prices rose a more-than-expected 0.3% month over month in January, up from 0.2% in December, slowing the pace of disinflation. On a year-over-year basis, the inflation rate dipped to 3.1% from 3.4% while the core rate held steady at 3.9%. Most concerning was a 0.85% month-over-month rise in core services ex housing, a metric watched closely by the Fed. Some observers have cautioned that there have historically been uncaptured seasonal effects in January CPI data and that the composition of the Consumer Price Index differs significantly with from the Fed’s preferred PCE measure. However, Friday’s much-larger-than- expected jump in producer prices, led by a rise in services prices, reignited fears that inflation has yet to be tamed. The odds of a May rate cut were trimmed to just 29% on Friday morning from nearly 70% early Tuesday. 

US retail sales surprise to the downside

Signs that consumer spending entered 2024 with less momentum than thought helped calm fears that the US economy is destined for no landing, not the soft landing that investors had hoped for. January retail sales unexpectedly fell 0.8%; the prior two months’ readings were revised lower. It should be noted that retail sales account for only about a quarter of consumer spending, services for the rest. 

Trump’s NATO remarks ruffle European feathers

Former US President Donald Trump said during a campaign stop last weekend that he would encourage Russia to do “whatever the hell they want” to NATO allies that fail to meet their military spending obligations. An advisor to Trump later suggested the potential for a two-tiered alliance, with only members in compliance with the 2% annual defense spending commitment being eligible for Article 5 protections, under which an attack on one member is seen as an attack on all. German Chancellor Olaf Scholz responded by saying that calling into question NATO’s mission is irresponsible and dangerous.

Barr says Fed closely watching banks’ CRE exposures

US regulators are “closely focused” on risks in commercial real estate loans and have stepped up downgrades of banks’ supervisory ratings and increased enforcement actions amid a continued downturn in the real estate sector, according to Fed Vice Chair for Supervision Michael Barr. On Thursday, the central bank issued guidelines for its annual stress tests that emphasize the risks inherent in commercial real estate. 

QUICK HITS

Ahead of last Sunday’s Super Bowl, US President Joe Biden called on companies to end shrinkflation. 

A slump in German office property prices accelerated in the fourth quarter to a 13% year-over-year decline, according to German banking association VDP. For the full year, prices dropped more than 10%. 

The Mortgage Bankers Association forecasts that almost 20% of US commercial real estate loans, totaling $929 billion, will mature this year.

Japan’s Vice Finance Minister for International Affairs Masato Kanda said this week that recent rapid yen depreciation is undesirable. He warned speculators that authorities are on call 24 hours a day, 365 days a year and are always ready to take appropriate steps, as needed.

Betting markets project that Joe Biden has a just a 27% chance of being reelected US president in November. Former President Donald Trump has a 44% chance, according to Real Clear Politics. 

Inflation in the United Kingdom came in lower than expected in January, falling 0.6% month over month while holding steady at 4% year over year. Core inflation was unchanged at 5.1%.  

By a vote of 214 to 213, the US House of Representatives this week impeached Secretary of Homeland Security Alejandro Mayorkas over the Biden administration’s handling of the US-Mexico border, the first impeachment of a cabinet secretary in nearly 150 years. Mayorkas is not expected to be convicted by the Democrat-controlled Senate. 

Both the UK and Japan reported a second consecutive quarter of negative economic growth in the fourth quarter of 2023. Japan’s economy shrank 0.4% last quarter while the UKs pulled back by 0.2%. Despite these technical recessions, economists do not fear deep economic pullbacks in the countries since labor markets remain strong there. 

US industrial production declined 0.1% from the month before in January while December production was revised down to flat. 

The European Commission sees slower growth but lower inflation in 2024. It cut its growth forecast to 0.8%, down from its fall forecast of a 1.2% expansion. The commission sees eurozone inflation falling to 2.7% in 2024 from 5.7% in 2023, a steeper drop than its earlier 3.2% forecast. 

European Central Bank President Christine Lagarde this week cautioned against rushing to cut interest rates amid rising wage pressures. 

 Fed Governor Christopher Waller said this week that there is no reason for a central bank digital currency in the United States as the banking system works well. 

Unemployment in Australia rose to a two-year high of 4.1% in January. 

The White House this week confirmed "troubling" intelligence reports on Russia’s antisatellite capability but said there is no immediate threat to national security. 

Hezbollah said Friday that it would escalate its fight with Israel after a series of tit-for-tat attacks. 

EARNINGS NEWS

With 79% of the constituents of the S&P 500 Index having reported for Q4 2023, blended earnings per share (which combines reported data with estimates for those that have yet to report) shows that earnings rose 3.1% compared with the same quarter a year ago, according to data from FactSet. Sales growth is up 3.9% year over year.