As US inflation proves even stickier than expected it’s increasingly likely that the Fed won’t have a good reason to cut interest rates any time soon unless the unemployment rate spikes.
Fed chair Jay Powell said last week that it was too soon to say if higher than expected inflation in January and February was more than just a “bump”.
After a third consecutive blowout in the consumer price index that bump looks more like a hill.
US CPI inflation hit a six-month high of 3.5 per cent in March. Core inflation, which excludes volatile food and energy prices, rose 3.8 per cent versus a 3.7 per cent rise expected by economists.
“These three recent uncomfortably high prints are shifting the burden of proof – hot prints will just be a confirmation of the new trend, while it’ll take more than one low print to shift the narrative back to slowing inflation,” RBC US Economist, Michael Read, said.
RBC lessened its expectation of US interest rate cuts this year to just one cut in December. Goldman Sachs pushed its forecast of the first US rate cut out to July from June. Barclays wound back its call for US rate cuts to just one cut this year. Former US Treasury Secretary Lawrence Summers said markets “have to take seriously” the chance the Fed’s next move on interest rates could be a hike.
Sticky inflation and the prospect of a further delay in interest rate cuts after higher-than-expected US CPI data sent the US 10-year yield soaring 20 basis points to a five-month high of 4.52 per cent.
Combined with rising geopolitical risks in the Middle East, a reduced chance of US interest rate cuts in the short-term also weighed on the Australian dollar, which fell as much as 2 per cent to US65c.
Delays in US interest rate cuts could also affect the timing of Australian interest rate cuts if the exchange rate falls sharply enough. It’s also bad news for the lofty valuation of the stock market.
Australia’s S&P/ASX 200 mostly recovered from a one-week low on Thursday as buoyant commodity prices and a weaker exchange rate boosted the resources sector.
But after rising more than 25 per cent in the past five months, the S&P 500 was trading at around 21 times forecast earnings per share for the next 12 months, 20 per cent above its decade average.
The S&P 500’s PE multiple translates to an earnings yield of 4.8 per cent earnings, a slim margin over the 10-year bond yield which rose 20 basis points to a five-month high of 4.52 per cent in the wake of higher than expected CPI data for March. It was the third upside inflation surprise in a row.
A spike in unemployment that sparked recession fears would also be bad news for stocks, even if it allowed the Fed to cut interest rates soon. If unemployment spikes the Fed will prioritise “maximum employment” over its “stable prices” objective. A recession would cause significant disinflation and interest rate cuts, but it would also trigger a major reset of earnings forecasts.
However, after stronger than expected economic activity and inflation data in recent months, a “no-landing” scenario for the US economy seems more likely than a recession or a soft landing.
The increasing valuation headwind for stocks – as “risk free” US Treasury bond yields rise in response to sticky inflation and diminishing rate cut expectations – puts a lot of onus on the earnings outlook from the US quarterly reporting season that kicks off this week.
The consensus March quarter EPS estimate for the S&P 500 has fallen 2 per cent over the past three months while the full-year 2024 estimate has fallen just 80 basis points as the December quarter estimate has been revised up. March quarter year-on-year growth is expected to be just 3 per cent.
Strong earnings from the Magnificent 7 or Fabulous 5 tech giants may keep propping up the US sharemarket, but corporates face sticky cost inflation and a high-for-longer interest rate outlook.
Like the US market, the Australian market has benefited from expectations that 2024 will be defined by interest rate cuts and sustained economic growth. The S&P/ASX 200 has risen 15 per cent since October even as the consensus earnings per share forecast fell about 6 per cent, lifting the PE multiple of the index to 16 times. That’s about 10 per cent above its long-term average.
“Sticky inflation and a resilient labour market have substantially diminished the bond market’s prior enthusiasm for policy rate reductions,” GSFM investment strategist, Stephen Miller, said.
At the start of the year the bond market was anticipating something close to 175 basis points of policy rate cuts or seven decreases of 25 basis points with a first cut expected in March.
Now the market only expects 40 basis points of cuts this year and no cuts until November.
GSFM’s Miller sees structural elements that will make that “last mile” on inflation harder.
The globalisation of labour supply and “export” of labour from large emerging market economies such as China and India is abating; globalisation of goods markets is in retreat as governments everywhere introduce protectionist measures under the guise of “industrial policy” and “national champions”; domestic regulation of goods and labour markets is increasing in scope; and baby boomer workforce participation is declining, limiting labour supply and lifting wages.
“The Fed must still be some way from contemplating any policy rate cuts and there is a real prospect that rate cuts might not come until 2025,” he said.
Bond markets might still need to make more room for such an eventuality.
In his view, more significant price adjustments may be needed in riskier assets like stocks.
He also sees some “nascent risk” that the Fed goes down the path of the ill-fated Arthur Burns-G. William Miller led Fed of the late 1970s, which cut rates before inflation was beaten.
ASX 200 down; US inflation dents Fed interest rate cut hopes
As US inflation proves even stickier than expected it’s increasingly likely the Fed won’t cut interest rates any time soon | Also today: ASX 200 trims sharp falls, Star down.
Welcome to the Trading Day blog for Thursday, April 11. Expected delays in US interest rate cuts could also affect the timing of Australian interest rate cuts if the exchange rate falls sharply enough. It’s also bad news for the lofty valuation of the stock market. The ASX 200 index closed 0.4 per cent lower at 7813.6 points, recovering from its early 1.2 per cent decline.
The Aussie dollar is near US65.21c.
More Coverage
Updates
Why US inflation dents rate cut hopes
ASX 200 ends down 0.4pc after US CPI blowout
Australia's share market ends only modestly weaker after a relatively sharp fall in the US market after higher than expected CPI inflation for March.
The resources sector lends support after the Australian dollar fell as much as 2 per cent to US65c and commodities stayed buoyant.
The S&P/ASX 200 index ends down 0.4 per cent at 7813.6 after hitting a one -week low of 7752.1 in early trading after a 1 per cent fall in the S&P 500.
Eight of 11 sectors fall, led by a 1.8 per cent fall in the property sector after the US 1-year bond yield jumped 20bps to a five-month high of 4.52 per cent.
Goodman Group bounces hard intraday to close down just 0.8 per cent.
Big banks and health care stocks are the biggest drags on the market with CBA down 1.2 per cent and CSL down 1.1 per cent.
Wesfarmers falls 1.1 per cent, James Hardie loses 2.4 per cent, Sonic drops 4 per cent and Scentre falls 3 per cent.
BHP gains 1.1 per cent and Woodside Energy jumps 2.1 per cent as crude oil gains. NextDC trading is halted for a $1.3bn capital raise for its data centre growth.
"We followed the US lead where US mkts lower, but despite all the negative news, the S&P 500 was still did not close down by over minus 1 per cent," says Bell Potter's head of institutional sales and trading, Richard Coppleson.
"So still – despite all that bad news – the S&P 500 has now gone for 286 days with without even one 2 per cent down day."
But while big tech limited the US fall, the S&P 500 equal-weighted index "showed a more sinister picture as that was down 1.7 per cent."
Geopolitical risk in the Middle East also has limited impact, even as Bloomberg says the US believes an Iran led missile attack on Israel is "imminent."
China to end Australian lobster ban: SCMP
China is set to end its ban on Australian live lobster imports, the South China Morning Post reports.
China Premier Li Qiang is scheduled to visit Australia in June in a move set to consolidate improving economic relations between Beijing and Canberra, the SCMP says, citing two unnamed sources.
"It is also expected that the unofficial ban on Australian live lobsters will be lifted as a signal of resuming a normal and friendly trade relationship for both sides," the source said.
The ban has been in place for more than three years.
China last month announced an end to its crippling tariffs on Australian wine, in a move that should see China return to being the Australian wine industry's biggest export market.
Who's at the Star show on Monday
An imminent inquiry into whether Sydney’s Star Casino was fit to hold its licence won’t examine the company’s regulator, as a who’s who of the Pyrmont venue are set to be grilled on Monday.
The outcome of the 15-week inquiry – led by barrister Adam Bell SC in what would be his second probe after a one in 2022 – could see Star Entertainment Group forced to close its flagship casino if it fails to convince it has reformed its culture.
Star's shares are down 2 per cent to 54.75c at 1.30pm AEST.
However, the inquiry, while probing the culture, financial resources, management and compliance of the group and venue, won’t look at the role of the regulator, the NSW Independent Casino Commission, or any possible failings on its own part while overseeing the venue’s operations.
Craig Collie exits Regal Funds
Healthcare specialist Craig Collie has departed Regal Funds.
Mr Collie was a portfolio manager and previously worked as the lead healthcare analyst at Macquarie Group.
More to come in DataRoom.
Santos pay, CEO incentives voted in
The Santos remuneration report sailed through a shareholder vote this morning with slightly more than 9 per cent of proxy shares against the resolution.
Meanwhile, a vote on chief executive Kevin Gallagher’s incentive package only attracted a negative vote of slightly more than 2 per cent. He told shareholders at the annual general meeting work on the $5.4bn Barossa LNG development is now 70 per cent complete.
Its share price is up 0.8 per cent to $7.81 at 1pm AEST on wider energy sector gains.
Metcash 'stepped in' to stop Coles' grab
The boss Metcash’s supermarkets arm Grant Ramage says the wholesaler was forced to step in and purchase a property in SA to stop Coles buying it and possibly throwing out the independent supermarket operating at that site.
He says Metcash was forced to match an inflated price just to keep Coles from grabbing it. It then sold the property to an independent supermarket operator at a lower price, taking a loss on the deal. Mr Ramage told senators at the inquiry into supermarkets this was an example of the “land banking” both Coles and Woolworths pursued to keep out competition.
Mr Ramage said the store in SA was very successful and Metcash became alarmed when Coles attempted to buy it. Coles offered a very high price for the site.
Metcash had informed the Australian Competition and Consumer Commission about the attempt by Coles to grab the SA property, but given concerns the regulator didn’t have the power to act, it stepped in and bought the property.
US rate cuts a matter of if, not just when
US central bank officials started the year with the wind seemingly at their backs. No more.
Another firmer-than-anticipated inflation report delivered a meaningful setback overnight to the Federal Reserve’s hope that it could buoy prospects of a so-called soft landing by dialing back some of the past year’s interest-rate increases.
Solid hiring and the prospect that inflation might settle out closer to 3 per cent than the Fed’s 2 per cent goal could call into question whether it will be able to cut rates until much later in the year without evidence of a sharper slowdown in the economy.
A third straight month in which prices were hotter than expected likely sends officials back to an uneasy holding pattern where they wait several more months for either better inflation data or the type of evident economic weakness they were hoping to avoid.
The latest data raises two different possibilities. One is that the Fed’s expectation that inflation continues to move lower but in an uneven and “bumpy” fashion is still intact —but with bigger bumps. In such a scenario, a delayed and slower pace of rate cuts is still possible this year. A second possibility is that inflation, rather than on a "bumpy" path to 2 per cent, is getting stuck at a level closer to 3 per cent. Without evidence that the economy is slowing more notably, that could scrap the case for cuts altogether.
– Nick Timiraos, The Wall Street Journal
China consumer inflation softens
China’s consumer prices rose at a slower pace in March as food and travel prices fell, official data shows.
The consumer-price index rose 0.1 per cent in March from a year earlier, compared with the 0.7 per cent increase in February, the National Bureau of Statistics said. A Wall Street Journal poll of economists had tipped 0.4 per cent growth.
Weak consumer prices may reignite deflation concerns after China ended a four-month streak of deflation in February. Food prices dropped 2.7 per cent in March and non-food prices increased 0.7 per cent in March.
Core CPI, which excludes volatile food and energy prices, rose 0.6 per cent in March, slowing from the 1.2 per cent rise in February. On a monthly basis, CPI declined 1 per cent in March, reversing from a 1 per cent increase in February.
Meanwhile, China’s producer-price index fell 2.8 per cent in March from a year earlier, compared with February’s 2.7 per cent fall and matching expectations. Producer prices stayed in deflation for 18 months in a row.
– The Wall Street Journal
ASX 200 trims fall to 0.6pc
Australia's share market halves a sharp intraday fall in the wake of a US selloff as bond yields soared after higher than expected CPI data.
The S&P/ASX 200 index is down 0.6 per cent as 7802.6 after hitting a one-week low of 7752.1. Most sectors are down with property, tech, utilities, consumer discretionary, health care and financials underperforming.
Energy leads after crude oil prices jumped on as Bloomberg said the US and its allies believe a major attack on Israel by Iran or its proxies is imminent.
BHP supports the materials sector after the A$ fell about 2 per cent.
The S&P 500 fell 1 per cent on Wednesday but has risen by about 1 per cent on average the day after falls of that magnitude this year.
ASX 200 hits new high; Platinum soars on Regal bid
New Hope's underlying earnings still solid on 'robust' coal price. Platinum urges no action amid Regal bid assessment. Casino operator Star agrees lender terms. Genesis back to claim control of dental group Pacific Smiles. Webjet demerger vote.
ASX closes at record high as US Fed rate cut nears
Alcoa rises on $US1.1bn cash-scrip Saudi stake sale. Austal soars on $670m US shipyard expansion contract. Fair Work Commission lands Virgin pilots deal. Police & Nurses Limited calls off merger with Beyond Bank.