US macroeconomic data this week fed hopes of a soft landing for the US economy. Most importantly, US consumer price inflation fell by more than expected. Bond markets greeted the news with a rally. Expectations that the cycle of monetary policy tightening is now over were reinforced. Policymakers remain on their guard: once bitten by the inflation bug, twice shy.
US inflation report bolsters soft landing narrative
In October, US consumer price index (CPI) inflation fell by more than expected to 3.2 % year-on-year (after a 3.7% rise in the 12 months to September), marking the first decline in four months.
Markets reacted jubilantly with a sharp fall in US Treasury yields and a rise in stock valuations. The yield on the benchmark 10-year US Treasury bond dropped to a three-month low of 4.43% before retracing some of that move. The S&P 500 rose by 1.9%, its biggest one-day jump since April.
Most importantly, the report showed a significant slowdown in rental inflation to 0.41% month-on-month. This effectively reversed a 0.56% rise in September. As a result, the rental disinflation trend remains intact, adding to market hopes of a soft landing for the US economy.
Falling rents on new leases have indicated for some time that rental inflation, the most influential single CPI component, would moderate. The slowdown in October alone accounted for 5 basis points (bp) on the slower month-on-month pace of core CPI, explaining most of the difference in overall core inflation in October relative to September.
The strength of the market reaction is perhaps due to the slightly weaker-than-expected core inflation, which dipped from 4.1% to 4% YoY, and rose by 0.2 % month-on-month.
Extrapolating from this data – and absent a major CPI upside surprise in the November data (released just before the US Federal Reserve’s next policy meeting on 11-12 December) – the Federal Open Market Committee (FOMC) will likely have to revise down the forecast it made in September for the level of core personal consumption expenditures at the end of 2023.
It would require very strong data for core inflation in the final two months of the year to hit the current forecast, hence a downward revision now appears very much on the cards. This would be the second consecutive downward revision the FOMC faces after a series of upward revisions to inflation projections.
The better-than-expected inflation report comes in the wake of the eurozone inflation report for October indicating that inflation fell to 2.9% in the 12 months to October from 4.3% in September, also reflecting this year’s declines in energy prices.
These more benign inflation readings look set to fuel speculation that central banks including the Fed, the European Central Bank and the Bank of England have finished raising rates. The Fed held its benchmark interest rate steady at a 22-year high earlier in November.
After this latest report, futures markets were pricing zero chance that the FOMC would lift rates at December’s policy meeting. Investors also advanced their estimates of when the Fed would start cutting rates, with markets now pricing in two 0.25 percentage point cuts by next July.
Policymakers are still wary
Nonetheless, policymakers remain cautious.
Fed Chair Jay Powell stressed last week that he and his colleagues would not be ‘misled by a few good months of data’, and that the Fed could still tighten monetary policy further if necessary.
Thomas Barkin, president of the Richmond Fed, echoed the message this week, warning that inflation might not be on a ‘smooth glide path down to 2%’ despite recent ‘real progress’.
US consumer remains resilient…
US retail sales fell by less than forecast in October, signalling the relative resilience of US consumers.
The headline number was better than expected, falling by only 0.1% rather than the 0.3% for which the market had been braced. The drop was spurred in part by a price-related fall in spending on petrol.
It was the first monthly decline since March, although September’s increase was revised higher to 0.9%.
Again, this data gives some support to expectations for a soft landing for the US economy.
…But further evidence of a rebalancing US jobs market…
US jobless claims increased by 13 000 to 231 000 (versus consensus forecasts for 220 000), with continuing claims also rising, indicating a cooling of the labour market.
With moderating job growth mostly due to slower new hiring, continuing claims are important to watch.
This week’s rise follows a rise of 32 000 last week. Seasonal-adjustment quirks are creating a more severe increase in the figures than is evident in the underlying data. Though the rise is a function of US Labor Department methods, the broad contours match deteriorating job availability in consumer surveys.
…And falling oil prices bode well for inflation
Oil prices fell again this week, reaching their lowest since mid-July as growing inventories in the US eased supply concerns.
Despite the current geopolitical tensions, oil prices have been under pressure for most of 2023, although they rose after the summer when Saudi Arabia and Russia led coordinated output cuts by OPEC+.
Brent crude, the international benchmark, fell this week by 4.1% to USD 77.84 a barrel after the US Energy Information Administration reported that crude inventories in the country grew by 3.6 million barrels last week to a total of 421.9 million, well above market forecasts.
Meanwhile, in Karlsruhe, Germany
On 15 November, just as Germany’s parliament was set to finally approve a painfully negotiated budget, the country’s constitutional court in Karlsruhe ordered that EUR 60 billion of funding for clean energy and industrial projects be cancelled.
The judgment almost exclusively hits projects championed by Chancellor Scholz’s Green party coalition partner, many of which have been funded ‘off balance sheet’.
The German government is now assessing the full implication of the court ruling on the ‘debt brake’. It seems the government will have to find a net EUR 24 billion in savings from the 2024 budget, most of which will come from reduced subsidies to large industries. Potentially, this ruling could force Germany into pro-cyclical fiscal tightening just when the economy is weakening.