US inflation gains leave little option for the Fed but to tighten amidst a slowing US economy
Posted onUSD: US May core CPI rises a solid 0.63%MoM in May, stronger than consensus for 0.5% and Citi at 0.47%. Base effects however see the Y/Y reading drop from 6.2% to 6.0%. Core goods prices are up 0.7%MoM and core services prices are also strong, rising 0.6%MoM with the gain in shelter prices particularly notable. Meanwhile, headline CPI rises 1%MoM and reaches a new recent high of 8.6%YoY with food at home prices up a strong 1.4%MoM and energy prices up a whopping 3.9%. It is difficult to find any component of CPI in May that would make the Fed comfortable in concluding that the pace of inflation is set to slow substantially any time soon. Indeed, the incipient weakness in US home sales on rising mortgage rates are expected to generate, if anything, upward pressure on rental markets that are already up 5.5% Y/Y, the highest for the cycle to-date. As affordability will not turn quickly, this suggests relief in this price measure won’t come until 2023. However, with consumer goods spending waning and supplies recovering, previous areas of strength are retreating though it may take much of the year for supply/demand to rebalance after the severe instability induced by COVID and stimulus measures. Food and energy supplies are now threatened by the conflict in Eastern Europe and US energy producers, for one, have yet to mount a strong rebound in new investment.
USD: But the larger recovery in consumer goods production and imports is showing the way forward - retail inventories are now starting to post rapid increases and overall, the CPI data remains consistent with a topping of inflation, particularly as average wages in the US are rising at a much slower pace than CPI year-to-date (3.9% vs 1.8% non-annualized). The US economy also seems to be showing signs of slowing as consumers face the inflation spike following last year’s demand boom. Indeed, the latest University of Michigan’s preliminary June index of consumer sentiment (also released on Friday) falls to 50.2 vs 58.1 forecast. Michigan inflation expectations for June sees another increase in 1Yr expectations, climbing to 5.3% vs 5.3% prior while 5-10Yr inflation expectations surge to 3.3%, highest print since June 2008. The Michigan data shows that just 13% of respondents expect incomes to outpace inflation, the smallest share in almost a decade.
USD: While consumer spending has remained robust so far, this broad deterioration of sentiment highlighted in the Michigan survey may lead them to cut back on spending and thereby slow US economic growth. Other US data such as a decline in durable goods buying conditions to a fresh record low also reflects a US economy that is losing momentum and therefore as the Fed tightens (likely 2 50bp back-to-back hikes this week and in July), the risk of a future recession rises. At the same time, progress toward rebalancing supply/demand is already taking place but inflation measures (with key components in the Index of Lagging Economic Indicators) would likely be the last place where this is likely to be reflected.
Solid Canadian jobs report to leave 50bp hikes on the table for BoC in July and September
CAD: Canadian employment rises by 39.8k in May, exceeding consensus for 27.5k. Meanwhile, the unemployment rate falls to its lowest since the 1970s at 5.1% even as the participation rate stays flat at 65.3%. The hourly wage rate of permanent employees increases by 4.5%YoY, showing a substantial pickup compared to the 3.4%YoY in April. With the participation rate remaining close to pre-pandemic levels, it would not be surprising to see more moderate increases in the monthly job numbers as the supply of workers remains constrained.
CAD: But Citi analysts point to the main highlight in the May employment report being the start of a long-expected acceleration in hourly wages. More recently, there seem to be some signs of a pickup in wage growth in other measures, such as strong unit labor costs in Q1 and average earnings in the payrolls report for March. Similar strength in wages is now starting to become more evident in the labor-force survey as well. Further strong wage growth would be a clear sign that excess demand in the labor market is contributing to underlying strong inflationary pressures. This keeps risks for the BoC tilted towards still more-hawkish outcomes. Citi analysts’ base case remains for 50bp rate hikes again in July and September.
Week Ahead – Fed FOMC, BoE, SNB and BoJ board meetings
USD: Fed to lift rates 50bp to 1.25 – 1.50% but markets to watch Fed statement and dot plot distribution - Wednesday FOMC meeting is the clear highlight of this week. After the upside surprise to May CPI and another climb in inflation expectations, markets expect a hawkish meeting. However, the move lower in risk assets could constrain Chair Powell That said, the decision is still very likely to see another 50bp rate hike that takes policy rates to 1.25-1.50% with the focus then shifting to the updated Summary of Economic Projections, in particular the median “dot” implied by Fed officials’ forecasts for the path of policy rates.
GBP: BoE to hike 25bp this week – BoE faces probably the most challenging macro backdrop among major G10 economies, of rising UK inflation and sharply slowing growth. Markets are pricing in nearly 170bps hikes for this year and 33bps for the June meeting. Citi analysts expect the BoE will opt for a 25bps rate increase to take the cash rate to 1%, thereby taking a measured approach to balance inflation and growth risks and potentially “buying” insurance against the possibility of downward wage rigidity. On balance, therefore, current market pricing looks aggressive given the strong fundamental headwinds in the economy.
CHF: SNB: ready to hike – Citi analysts go against consensus to look for a 25bp hike from SNB this week - a robust Swiss economy, signs that wage growth is picking up and a weakening Franc amid globally hawkish central banks may allow the SNB to hike its policy rate by 25bp to -0.5% this week. Swiss rate markets are pricing 16bps for this week’s SNB meeting followed by two 25bp SNB hikes in September and December, respectively as the ECB pre-announcing a 25bps hike for July has increased the probability of an SNB hike in June.
JPY: Japan: BoJ monetary policy meeting – Citi analysts expect monetary policy to be unchanged at this week’s MPM, and indeed remain so for the remainder of Governor Kuroda’s term. The team sees a comparatively high likelihood of policy modifications to address side-effects under his successor. Citi analysts expect NIRP will end and the YCC target narrowed (to 5y from 10y) in September 2023, but the timing is shrouded in uncertainty given growing pressure on monetary policy from fiscal expansion in Japan.