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A step in the right direction: U.S. inflation eases in April after hot start to the year
Executive summary:
- Core inflation slowed to 3.6% in April in the U.S.
- U.S. equity and bond markets rallied sharply in the wake of April's inflation report
- European equities rose as the region's economic outlook improved
On the latest edition of Market Week in Review, Director of Investment Strategies, Shailesh Kshatriya, and ESG and Active Ownership Analyst Zoe Warganz discussed the U.S. inflation and retail sales reports from April, as well as the market’s reaction. They also chatted about the improving economic outlook in Europe.
U.S. inflation cools for the first time in 2024
Warganz and Kshatriya began with a look at the U.S. consumer price index (CPI) report for April, which was published by the Labour Department on May 15. Kshatriya noted that markets were a little anxious in the lead-up to the report’s release, given that inflation had come in hotter than expected during the first three months of the year.
This time around, however, inflation took a step in the right direction, he said, with the core CPI slowing to a monthly gain of 0.3%—down from a 0.4% increase in April. That brought the annual core inflation rate down from 3.8% in March to 3.6% in April, Kshatriya noted.
“Importantly, some of the key services categories that had been somewhat sticky over the past few months—such as shelter and transportation—also eased during April,” he remarked. Kshatriya added that while the overall April inflation numbers were encouraging, one month doesn’t make for a trend. “The U.S. Federal Reserve (Fed) will continue to be very data-dependent as it weighs potential changes to monetary policy, and will be looking carefully at upcoming reports to get a more complete sense of the inflation picture,” he stated.
The week of May 13 also saw the release of U.S. retail sales figures for April, Kshatriya stated, noting that the numbers were disappointing. He said that one of the key indicators in the report is the performance of the control group—essentially, the core retail sales numbers that feed into GDP (gross domestic product) data. “The control group measure actually declined 0.3% on a month-over-month basis, falling short of expectations for a small gain,” Kshatriya observed, characterising this as a miss for consumer spending.
However, Kshatriya said the miss wasn’t entirely surprising, as he’s been expecting spending trends to slow as the year progresses. Why? Excess savings accumulated by consumers during the COVID-19 pandemic have mostly been exhausted, Kshatriya explained. “Walmart’s better-than-expected earnings report is evidence of this trend, as it shows a shift in behaviour toward more value-oriented consumption,” he said. Overall, though, Kshatriya said the outlook for consumer spending will hinge most on the state of the U.S. labour market, which continues to look fairly decent.
U.S. stock market hits record highs
Next, Warganz asked Kshatriya how U.S. markets have been interpreting the latest inflation data. “Equity markets are certainly pleased with April’s numbers,” he stated, noting that major U.S. equity benchmarks like the S&P 500® Index and the Dow Jones Industrial Average hit record highs on May 15. Kshatriya said the strong market rally has bumped Russell Investments’ composite contrarian indicator, which measures investor sentiment, closer to an overbought level. “It’s not necessarily indicating euphoric conditions outright, but it could lean in that direction if the market rally continues,” he remarked.
Bond markets also reacted strongly to the signs of easing inflation, Kshatriya said, with the yield on the benchmark 10-year Treasury note falling to its lowest level in a month. Over the past few weeks, government bond yields have declined by approximately 30-35 basis points—a remarkable drop in such a short amount of time, he noted.
In a drastic change from the start of the year, when traders were anticipating up to seven rate cuts in 2024, markets are now pricing in two Fed rate cuts this year, Kshatriya said. “Current expectations call for the first cut to come in September, which generally aligns with our thinking at Russell Investments,” he stated.
Are brighter days in store for the European economy?
Warganz and Kshatriya closed with a review of the latest economic data from Europe, which Kshatriya called positive and encouraging. On a quarter-over-quarter basis, euro area GDP grew by 0.3%, he said—a welcome recovery from the second half of 2023, when the region’s economy experienced a mild contraction.
A glance at forward-looking indicators shows that industrial production in Europe is on the upswing, Kshatriya said, with improvements in business surveys also starting to come through. He added that Germany’s ZEW economic sentiment index for May hit its highest level since February 2022, pointing to increased optimism about the outlook for Europe’s largest economy.
Perhaps the most encouraging sign of all is the ongoing disinflation trend in the broader European economy, Kshatriya said, noting that this could lead to an initial rate cut by the European Central Bank (ECB) as soon as June.
He said that the improving economic situation in Europe has also lifted equity-market performance in the region, with European equities actually outperforming their U.S. counterparts so far this quarter. “After the stagnant growth in 2023, this shift has been nice to see, and has helped boost European equity markets a little more,” Kshatriya concluded.