With the unemployment rate at 4.4% (ie. lower that the Fed’s long-run estimate) and most measures of the labour market on an improving trend the Fed is likely to remain committed to returning monetary policy to a more ‘normal’ setting and won’t be derailed by two months of softer inflation.
- Underwhelming US CPI prints in March (-0.3%) & April (0.2%) are not enough of a trend to de-rail Fed tightening, but should we be alarmed?
- A number of factors have been putting a cap on inflation for some time now, including modest global economic growth, anaemic wages growth and falling commodity prices as well as structural changes in demographics and technology.
- Mid-2016 saw inflation pick up off the back of rising oil prices & improving economic data.
- This helped cement a more active phase of monetary policy from the US Fed and the end to further easing from the BoJ, ECB and BoE.
- More recently, however, inflation has turned down a little again - led lower by oil prices and still very soft wages.
- Although we are still expecting rate hikes in June and September, recent data suggests investors should be alert, not alarmed.
Global Inflation Takes a Turn Back Down
Source: Bloomberg. Data to 15 May 2017.
2016 Reflation, a false dawn?
For much of the past 12 months inflation has been gradually increasing around the world with the recovery in commodity prices and improving economic growth. This led to what has become known as the “reflation” trade, rising inflation, rising yields and an inflection in monetary policy easing. Since early 2017 we’ve seen inflation moderate in the US, China, Europe and Japan as commodity prices have declined from their recent highs, is this the end of the reflation trade or is it just a bump in the road?
Recent US CPI Underwhelms, but not yet a trend
In the US the March Consumer Price Index (CPI) surprised to the downside, falling by -0.3%/mth taking the annual pace of inflation down to 2.4%/yr from 2.7%/yr. This was then followed up by a soft April report, which saw the annual rate moderate further to 2.2%/yr.
At the same time, the US Federal Reserve’s (the Fed) preferred measure of underlying inflation, the core PCE, declined from a recent peak of 1.8%/yr in January to 1.6%/yr in March. Some of this decline can be put down to temporary factors – such as the moderation in oil prices, a decline in mobile phone communication prices, as well as some sharp falls in medical costs but there are also some potential signs of broad weakness in housing and health costs.
….and unlikely to change the Fed’s tightening stance
Given the Fed’s inflation mandate, does this downturn in US inflation mean anything for their monetary policy path? With the unemployment rate at 4.4% (ie. lower that the Fed’s long-run estimate) and most measures of the labour market on an improving trend the Fed is likely to remain committed to returning monetary policy to a more ‘normal’ setting and won’t be derailed by two months of softer inflation.
Our view remains for two further rate hikes from the Fed this year – in June and September. Further, at the December Fed meeting we expect details to be announced around the Fed’s balance sheet, including a start to a ‘tapering’ of the Fed’s Treasury and Mortgage-Backed bond reinvestment program – which will gradually begin to shrink the Fed’s $US4.5trn balance sheet.
Globally, inflation appears to be falling as well
It is not just US inflation that has moderated in recent months. China’s CPI inflation has fallen from a high of 2.5%/yr in January to 0.8%/yr in February, before some recovery to 1.2%/yr in April. This volatility has been driven partly by Chinese New Year effects and, significantly, food prices – which have been very volatile.
Both Japanese and EU inflation is also off its recent highs – with the moderation in oil prices playing a part here. We do not, however, expect that this decline in recent inflation will be enough to push either the Bank of Japan (BoJ) or the European Central Bank (ECB) into easing monetary policy further.
But with labour markets tightening, reflation could just be a matter of time…
So is the global reflation trade over yet? Probably not, with labour markets continuing to tighten and excess capacity being worked out of the system it seems that higher wages and inflation are simply a matter of time, it might just take a little longer than expected.
This material has been prepared and issued by First Sentier Investors (Australia) IM Ltd (ABN 89 114 194 311, AFSL 289017) (Author). The Author forms part of First Sentier Investors, a global asset management business. First Sentier Investors is ultimately owned by Mitsubishi UFJ Financial Group, Inc (MUFG), a global financial group. A copy of the Financial Services Guide for the Author is available from First Sentier Investors on its website.
This material contains general information only. It is not intended to provide you with financial product advice and does not take into account your objectives, financial situation or needs. Before making an investment decision you should consider, with a financial advisor, whether this information is appropriate in light of your investment needs, objectives and financial situation. Any opinions expressed in this material are the opinions of the Author only and are subject to change without notice. Such opinions are not a recommendation to hold, purchase or sell a particular financial product and may not include all of the information needed to make an investment decision in relation to such a financial product.
CFSIL is a subsidiary of the Commonwealth Bank of Australia (Bank). First Sentier Investors was acquired by MUFG on 2 August 2019 and is now financially and legally independent from the Bank. The Author, MUFG, the Bank and their respective affiliates do not guarantee the performance of the Fund(s) or the repayment of capital by the Fund(s). Investments in the Fund(s) are not deposits or other liabilities of MUFG, the Bank nor their respective affiliates and investment-type products are subject to investment risk including loss of income and capital invested.
To the extent permitted by law, no liability is accepted by MUFG, the Author, the Bank nor their affiliates for any loss or damage as a result of any reliance on this material. This material contains, or is based upon, information that the Author believes to be accurate and reliable, however neither the Author, MUFG, the Bank nor their respective affiliates offer any warranty that it contains no factual errors. No part of this material may be reproduced or transmitted in any form or by any means without the prior written consent of the Author.
In Australia, ‘Colonial’, ‘CFS’ and ‘Colonial First State’ are trade marks of Colonial Holding Company Limited and ‘Colonial First State Investments’ is a trade mark of the Bank and all of these trade marks are used by First Sentier Investors under licence.