Bull Steepeners, Inflation Dynamics and BoE to Hike

Good Inflation or Bad Inflation?

Slowing headline CPI inflation in the US was what the market wanted – stocks rallied led by the Nasdaq as yields compressed, expectations for a Fed hike in June diminished somewhat, from 20% to 10%. But then overnight China’s slowing inflation suggests waning global demand, which points to a harder landing than the robust US labour market combined with slowing inflation might suggest. So which of the slower inflation do you think is more important? The fact is it’s going to be incredibly hard to bring inflation down to 2% without smashing the consumer and so far the consumer is holding up. Jobs are holding up. So does that mean we ought to accept permanently higher inflation? I think it might – just accept we are poorer, as Huw Pill put it. Without meaningful shifts in productivity growth, it is hard to see anything else.

Inflation Policy Up in the Air

Global central banks are heading towards some kind of a pause as they approach a ceiling – I'm not sure if that means the Fed doesn’t hike in June. I think, on the balance of how I read it, that the Fed is keeping June open for a hike as it would prefer to do that and then pause, then stop now and have to start again in September as real and expected inflation re-accelerate. Powell wants to be Volcker, not Burns. The market is well priced for a pause, but it expects a lot more in cuts – the market is misjudging how long CBs keep rates restrictive. BofA: “Getting inflation under control will very likely require a recession... the 1970s and 1980s may seem like ancient history but they provide the closest analogy to today.” The risk is that they pause too soon and without the labour market cracking properly inflation would just re-accelerate. We have a new inflation dynamic – this cannot be fixed with a few hikes. Until the consumer cracks I fail to see 2% being achieved. This is not necessarily a BAD thing. What is wrong with 3-4% inflation? A more fragmented world, disruption in global value chains and a period of global relative stability giving way to lasting instability will result in higher costs.

Equity Boosted, BoE Later

Core inflation rose 0.4% over the month, 5.5% year-on-year. The headline rate rose by 4.9%, down from the 5% registered in March. Short-end yields fell sharply, dragging the dollar down, creating a firm bull-steepening pricing in four cuts by Jan (!) whilst stock markets initially notched firm gains along with gold. Stocks ended off their highs, the Dow actually falling marginally and the S&P up 0.45%. The dollar initially sold off but has bounced and taken out a 1-week high against major peers, with DXY futures testing the 101.70 resistance again. GBPUSD is softer, testing the week lows at 1.2580 area ahead of the Bank of England monetary policy meeting later – more of a dollar move we think, plus rejection at the long-term trend line.

Bad slower inflation?

China CPI rose at the slowest pace in more than two years and factory gate prices fell further into deflation territory. CPI rose 0.1% yoy vs fc 0.4%, PPI fell 3.6% yoy vs fc -3.2%. US PPI inflation will confirm or deny the narrative – seen at +0.3% month-on-month, +0.2% for core.

The Bank of England will raise rates by 25bps today – inflation remains above 10%, so the situation is way more acute than in the US. Moreover the economic data is holding up much better than forecasts last autumn indicated. I’d expect the Bank to signal more tightening is likely going to be warranted. . "If there were to be evidence of more persistent pressures, then further tightening of monetary policy would be required," the BoE said in its policy statement in March. The data since then hardly indicates easing in inflation pressure. Airy fairy guidance to remain. The problem the BoE faces is two-fold, neither of which it can do anything about: one is it was too slow in its pace of tightening – there was never a ‘whatever it takes’ philosophy, so it never jumped in front of the inflation steamroller. Two is the mortgage market and a tonne of fixed rate deals rolling off over this year. The good news it’s less demand-driven so it will hope it can sit and wait it out. It will hope that the lag of hikes and base effects from energy will do the job now and this 12th hike could be its last. The market probably will think otherwise – but the market keeps ignoring the Fed, too. Remember the BoE is basing whether to hike on forecasts for inflation in two years’ time, not what is coming down the pipe in the coming months. Base scenario is a 25bps, split MPC with maybe 1-2 saying no hike, and growth forecasts revised up.

Debt Ceiling Tussle Continues

Donald Trump, ever the brinkman, called on the US to default if there are not massive spending cuts. Invariably this is not the way things are handled. “As someone in DC put it: Passing the debt ceiling is like passing a kidney stone: Everyone knows it will ultimately pass, it is just a question of how painful it will be." - Pimco’s Cantrill. But for Trump it’s all about the art of the deal and taking a hard line in negotiations are the way he works. Hard to see the market pushing out of the crabby range until it’s resolved.

GBPUSD runs into long-term trend resistance, momentum still with the bulls.