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Is U.S. inflation still heading in the right direction?

Executive summary:

  • With a 0.36% increase from February, the U.S. core CPI reading for March exceeded consensus expectations
  • The European Central Bank hinted it could start cutting rates in June
  • Fitch downgraded China's debt outlook, citing economic growth risks

On the latest edition of Market Week in Review, Investment Strategist BeiChen Lin and Product Operations Analyst McKenna Painter unpacked the latest U.S. inflation numbers. They also discussed recent rate decisions by the European Central Bank (ECB) and the Bank of Canada (BoC) as well as the economic and market outlook for China.

U.S. consumer prices rise by more than expected in March

Painter and Lin kicked off their conversation with a look at the U.S. CPI (consumer price index) report for March, published by the Labour Department on 10 April, Lin said that the March numbers were a little bit on the disappointing side, with the core CPI rising 0.36% from February – hotter than the 0.30% monthly increase expected by analysts. "March marked the third month in a row with a slightly-higher-than-anticipated monthly increase in core inflation," he said, explaining that price pressures also surprised to the upside in February and January. Lin added that much of March’s upside surprise stemmed from transportation services, with vehicle insurance in particular seeing a notable upward tick.

"The bottom line here is that the U.S. Federal Reserve’s (Fed) fight to lower inflation to 2% was always going to be challenging – particularly because it’s not a battle where the inflation rate can necessarily keep trending down linearly over time," Lin stated. That said, he does believe U.S. inflation will continue to cool throughout 2024, but stressed there could very well be some instances where there’s a hiccup or two along the way.

Interestingly enough, Lin noted that the PPI (producer price index) report for March, released one day after the CPI report, actually came in slightly softer than expected, rising 0.2% on a month-over-month basis. In addition, data from the Atlanta Fed’s wage tracker showed the pace of wage inflation moderated further in March, he said.

"On balance, I think this shows that inflation is still likely headed in the right direction – but that the fight to bring it back to 2% will not be an easy one," Lin stated. He added that although the Fed might need to push out its first interest-rate cut a little bit later than originally anticipated, he expects the central bank to still be in a position to cut rates at some point this year.

June rate cuts possible in Europe and Canada

Speaking of central banks, Lin said that both the ECB and BoC elected to leave their benchmark lending rates unchanged during meetings the week of 8 April, which he noted was largely in line with investor expectations. However, with growth in both regions relatively subdued and inflation continuing to decline, he said he expects both banks to likely start cutting rates soon – possibly in June.

"Both Canada and Europe are in similar positions today, with somewhat lackluster growth, unlike in the U.S., where economic growth remains resilient," Lin explained. He said that ECB President Christine Lagarde went as far to note that there were some ECB officials who might have preferred to cut rates at the bank’s 11 April meeting, rather than at its next meeting in June.

Ultimately, however, the ECB chose to hold off a little bit longer on a rate cut – for largely the same reasons the BoC did, Lin said. "Both banks have made good progress on taming inflation, but they want to have more confidence that inflation is headed sustainably back down to its 2% target before lowering rates," he stated.

What’s the outlook for Chinese equities?

Painter and Lin concluded by discussing the latest headlines surrounding China, including ratings agency Fitch’s decision to place Chinese debt on a negative outlook. "From our perspective at Russell Investments, we don’t think investors need to be too worried about the Chinese market," Lin said, explaining that despite the economic headwinds buffeting the country, inflation remains relatively subdued in China. This is important, he said, because it allows the Chinese government to deliver more fiscal stimulus without having to worry about inflation getting out of control.

"Importantly, China remains very focused on achieving solid economic growth, as evidenced by its 2024 GDP (gross domestic product) growth target of 5%," Lin remarked. In order to achieve that, he said more stimulus will likely be necessary – but stressed that the government has the room and the capacity to do so.

He finished by noting that Chinese equities have underperformed the broader global equity index this year, meaning that valuations are not stretched. In fact, Lin said that from his vantage point, they actually appear somewhat cheap. "Ultimately, staying disciplined and sticking to a broadly diversified portfolio is important during today’s times of uncertainty," he concluded.

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