A monstrous US CPI print for April shocked the market, driving down US equities, lifting US Treasury yields and supporting the USD. The fall in risk appetite has seen the NZD and AUD hit the hardest, overnight extending the losses during NZ trading hours and both down 1.4% from this time yesterday.
The warning signs have been lurking for an inflation shocker, with a number of indicators pointing to rising and strong global inflationary pressure and the mild upside surprise in the US CPI in March has been followed by a monster of a result in April. The core CPI figure rose by 0.9% m/m and 3.0% y/y, the latter being a massive 0.7 percentage points above market expectations and the highest annual inflation since 1996.
The headine CPI rose by 0.8% m/m, taking the annual increase up from 2.6% to 4.2%, exacerbated by base effects. However, the 3-month and 6-month annualised figures of 5.6% and 3.3% respectively suggest that more than base effects are going on, and on that note we can point to the reopening of the economy as a clear upward factor in inflation. Used cars and trucks contributed close to a third of the overall CPI result and around 60% of the monthly increase came from just five components – used cars, rental cars, lodging, airfares and food away from home.
Fed policy makers have been quick to highlight that they still believe higher near-term inflation to be transitory. Vice chair Clarida was honest enough to admit that he was surprised by the CPI figures but he called it “one data point” and ran the party line that inflation would return to 2% or “somewhat above” the Fed’s longer-run goal in 2022 and 2023, adding that “the economy remains a long way from our goals and it is likely to take some time for substantial further progress to be achieved”. The Fed’s Bostic said that we should expect a fair amount of volatility in inflation and that transitory moves in inflation don’t warrant a policy response.
Key to the markets from here is the next few monthly CPI prints and how inflation expectations respond. While the CPI print was a shocker, the question on whether or not inflation will prove to be transitory was not answered today. The longer the string of strong month-on-month CPI increases, the more uncomfortable the Fed will become in its view. Market-based measures of inflation expectations have already been trending upwards for some time now – the 10-year break-even rate spiked up to a fresh eight-year high of 2.59% overnight – so the Fed will be more interested in how household and business inflation expectations track.
The market hasn’t taken the inflation surprise kindly, with the S&P500 currently down 1.7%, now down some 3½% from Friday’s record close, adding in the poor price action earlier this week. The IT and Consumer Discretionary sectors are leading the falls, with Energy the only sector in positive territory, supported by a lift in oil prices, with Brent crude up over 1% and approaching the USD70 mark again. Commodity prices overall remain well supported, as one would expect in an inflationary environment, with Bloomberg’s commodity price index showing gains despite the stronger USD backdrop.
Bond markets have been whacked as well, although gains in yield have been limited to the extent that higher inflation has been on the worry list for some time for bond investors. The 2-year Treasury rate has barely moved, underpinned by expectations that the Fed will still be slow in raising rates, while the 10-year rate is up 7bps to 1.69%, trading at its high for the day.
Higher US-global rate spreads and weaker risk appetite have lent some support for the USD, which is higher against all the majors bar the CAD. The NZD and AUD have been whacked the hardest. After drifting down during the NZ trading session – perhaps on some profit taking ahead of the US CPI risk event – they have fallen further to be 1.4% down on this time yesterday and near their lows for the session. The NZD is around 0.7160 and the AUD is around 0.7730.
GBP, EUR and JPY also show notable falls from this time yesterday, down in the order of 0.6-0.8%.
The inflation shocker raises the question on whether this changes our negative outlook for the USD. Our initial reaction is no. The combination of higher inflation, a massive fiscal deficit and strongly rising trade deficit are all USD-negative. If US inflation is, say, 1% higher than expected then the equilibrium fair value of the USD is 1% lower. Changing interest rate expectation and gyrations in risk appetite can obviously have a positive short-term impact on the USD, but these shouldn’t affect the medium- term trajectory. The biggest risk to our positive NZD/USD view is if inflation does get out of hand, requiring a decent interest rate response by the Fed and risk assets come tumbling down from their lofty levels.
In other economic news, the UK economy contracted by 1.5% q/q in Q1, but the monthly track showed a decent pick-in in growth in March, confirming that a strong rebound is underway as lockdown restrictions ease. On the weak side, euro area industrial production rose just 0.1% in March, well below expectations, while China credit growth slowed in April after a record first quarter, encouraged by the PBoC’s intention to slow down credit expansion.
The domestic rates market showed upside pressure to yields yesterday, not helped by the global backdrop. The 10-year NZGB and swap rates were both 5bps higher at 1.84% and 1.97% respectively. More upside pressure is likely today, given the overnight move. Strong demand saw LGFA issue $750m 10-year bonds after initially offering $300m of these bonds, with the margin set at 36bps, at the lower end of the indicative margin range of 35-38bps.
Tonight sees the release of US PPI data, with a good chance of another upside surprise, but the market shouldn’t respond to that. Initial jobless claims are expected to continue to show signs of trending lower.