U.S. inflation eases further. Is a September rate cut more likely?

Transcript

welcome to the Russell Investments Market week and review for the weekending July 12th 2024 I'm your host Chris cman Regional director for Southwestern Ontario joining me today with sharp insights into the latest economic Trends around the globe is my wonderful colleague and investment strategist b chenin b Chen how are we doing today doing well how are you Chris I'm fantastic thank you for asking but we've got a lot to unpack this week and perhaps there's no other more important place to start the diving into the June CPI numbers released earlier this week in the US so bayat what do the latest us CPI numbers indicate about the progress of the inflation fight and when can investors expect the First Fed rate cut to happen sure thing Chris so the CPI numbers that were released earlier this morning on Thursday July 11th were pretty good news from an economic perspective analysts were looking for a core inflation of around 0.2% month over month and instead we got core inflation that was closer to 0.06% month over month and that's an important sign because ultimately as you know Chris the FED has for some time now been trying to get inflation back down towards the 2% Target that's why they've had to lift interest rates up up from near zero up to the current level of between 5 and a/4 and 5 1/2% in order to try to bring inflation back down towards Target and we are seeing progress this inflation report means that in the second quarter of 2024 the momentum on that disinflationary path continued even though the first quarter was a little bit more challenging and from our perspective at Russell Investments we continue to think that over time the FED will likely be successful in bringing inflation back down to that 2% Target but there is that minor caveat that it doesn't mean that every single report is necessarily going to be smooth nevertheless I do think that today's report was a pretty encouraging one and I think that it further makes the case that the Federal Reserve should be in a position to make their first rate cut in September this year in terms of the market reaction today was actually quite interesting because we saw large cap equity as measured by the S&P 500 actually end slightly lower on the day instead of higher and I think the reason for that was because there was already a lot of optimism baked into large cap us equities when we look at our proprietary measure of investor sentiment here at Russell Investments we see a lot of signs that investor sentiment is directionally overbought and it's getting close to but not quite yet at that Euphoria level so because so much optimism has already been effectively priced in that's probably one reason why you didn't see a more positive reaction from large cap equities on the other hand what we saw today was small cap equities did quite well the Russell 2000 was up sharply as of July 11th 2024 on the day and partly because small cap equities are generally more rate sensitive than large cap equities so if markets are becoming more confident that the Federal Reserve will be in a position to cut interest rates then it's understandable to see that reaction from small cap equities although it's also worth noting that even with today's positive performance from small caps small caps are still significantly lagging behind large cap equities year-to date in 20124 and then finally just on the bond side of things we did see bond yields fall quite sharply today as a result of the better than expected inflation data as well awesome shifting gears now to Canada which is where I'm based out of and I know your former home country we've got our big CPI announcement for the month of June happening on Tuesday of next week July 16 May CPI in Canada as we know came in a bit hotter than expected so what should investors be on the lookout for on Tuesday when June CPI numbers are released yeah Chris I definitely miss Tim Horton's and you're absolutely right I think the June CPI report that's going to be released for Canada is absolutely critical the bank of Canada's next policy meeting is going to be later this month in July and so the inflation report for the month of June is going to be the last last big report that the Bank of Canada will have access to before they have to make their next decision and the Bank of Canada is in a bit of a tough spot because on the one hand when we look at the growth Dynamics and we look at the labor market in particular the job market in Canada is far weaker than the job market in the US the most recent June payrolls report suggested that the Canadian unemployment rate actually increased compared to the month of May and the Canadian unemployment rate was actually higher than what people were expecting So based purely on the labor market dynamics one might think while the Bank of Canada should be cutting interest rates at the next meeting the only tricky part for the Bank of Canada though is that when we look underneath the surface of that June payrolls report we saw that wage pressures actually accelerated in Canada for the month of June the reason why that could be a complicating factor is because generally speaking wages are a key input cost for services businesses and although the correlation isn't always one to one there is a pretty good connection between wage pressures and ultimately Services inflation and if you think back to the May CPI report for Canada Services inflation was a bit on the sticky side and so I think the June report that's going to be released on Tuesday is going to be absolutely critical in determining if the Bank of Canada can cut rates once again if the June CPI report shows further progress on the bank of Canada's inflation fight if they can bring core inflation down then I think the bank of can Canada would be in a good spot to be able to cut interest rates at their July meeting but if core inflation remains sort of stuck at that 2.7% year-over-year level or if it actually even slightly re accelerates from that 2.7% year-over-year level then I think the Bank of Canada might even have to defer their F defer their second rate cut to the month of September it's going to be a pretty important report to watch so for those who are based off out of the West Coast of Canada make sure you set your alarm clocks early in the morning wonderful I know myself and a lot of my fellow Canadians will be glued to our computers on Tuesday to see where June CPI numbers come in Switching gears now to the other side of the world what's the third Plum that's taking place in China next week and why is it worth monitoring so the third plenum is one of the key policy meetings of China and the reason it's worth monitoring is because the Chinese government has announced a 5% GDP growth Target for 2024 if that number sounds familiar it's because it's the same growth Target that they had set in 2023 but the key difference is in 2023 it was relatively easier to hit that 5% GDP growth Target because of a relatively weaker year of activity in 2022 now as we stand here in 20124 it's going to be harder to achieve that 5% growth Target without doing more stimulus now from our perspective at Russell Investments we think that the government of China is very committed to that 5% growth Target and we think that they're willing to do what it takes in terms of stimulus in order to be able to achieve that growth Target and we do think you know having seen some positive momentum in terms of the the stimulus measures that they've announced thus far we do think that with additional stimulus they could be on track to achieve that growth Target of around 5% but it's going to be very important to monitor exactly what type of stimulus measures get announced what are the magnitude of some of those stimulus measures and what sectors those stimulus measures are aimed at for example we know that certain sectors like the property Market in China has been in a little bit of a tougher spot we know that consumer confidence in China has been in a little bit of a tougher spot so it be important to see where that stimulus is aimed at as well so that's why we're going to be monitoring that closely outstanding baitch thank you as always for your wonderful insights and knowledge while summer vacation might be consuming calendars there's still no shortage of key topics across the market for us to discuss that concludes this week's Market week in review stay informed invest wisely and we'll see you back here next week hi I'm Sophie an head of portfolio and business Consulting at Russell Investments if you liked what you just saw and heard consider subscribing to our YouTube channel or check us out on LinkedIn thanks for tuning in

Executive summary:

U.S. inflation eased further in June, strengthening the case for a Fed rate cut in September
June's inflation report could sway Canada's central bank to hold off on a second rate cut
Additional stimulus measures may be announced at China's upcoming Third Plenum meeting

On the latest edition of Market Week in Review, Investment Strategist BeiChen Lin and Regional Director Chris Kalman discussed the highlights from June’s U.S. inflation report. They also chatted about how Canada’s June inflation numbers could impact the Bank of Canada’s (BoC) next decision on rates, and finished with an overview of what to expect at China’s Third Plenum meeting.

‘Encouraging’ U.S. inflation report for June

Kalman and Lin began with a look at the main takeaways from the U.S. consumer price index (CPI) report for June, which was published July 11 by the Labor Department. Lin characterized the report as good news from an economic perspective, with core inflation rising just 0.06% from May, versus consensus expectations for a monthly increase of 0.2%. Meanwhile, headline inflation eased from 3.3% in May to 3% in June, he said.

“These latest numbers show that the U.S. Federal Reserve (Fed) is continuing to make progress in its quest to bring inflation back down to its 2% target,” Lin remarked. He emphasized that importantly, the second quarter was marked by an overall slowdown in consumer prices—a welcome change from the first three months of the year, when consumer prices largely reaccelerated.

Lin believes the Fed will likely be successful in lowering inflation to 2%, although he stressed that not every single report will show a linear decline. Overall, though, he said the June CPI report in particular is encouraging and strengthens the case for a September rate cut from the Fed.

The market reaction to the U.S. inflation numbers was somewhat interesting, Lin said, pointing out that large cap equities—as measured by the S&P 500® Index—actually fell slightly on July 11. Why? He said it’s probably because so much optimism has already been baked into large cap U.S. equities, which repeatedly reached new highs in early July. “Our propriety measure of investor sentiment suggests that sentiment is directionally overbought and is getting close to—but not quite at—a level of euphoria,” Lin explained.

He noted that conversely, small cap equities actually performed well in the wake of the June U.S. inflation report, with the Russell 2000® Index of small cap stocks rising sharply on July 11. “This favorable reaction can be partially attributed to the fact that small cap equities are generally more rate-sensitive than large cap equities. With markets becoming more confident the Fed will be in a position to cut rates soon, the sharp tick upward among small cap equities makes sense,” Lin stated. However, he added that even with their strong performance on July 11, U.S. small cap stocks are still lagging significantly behind their large cap counterparts so far this year.

All eyes on Canada’s June’s CPI numbers

Shifting the conversation to Canada, Kalman noted that the country’s June CPI report will be published on July 16. Lin said that in light of May’s unexpected increase in inflation, the June numbers will be absolutely critical in determining if Canada’s central bank can cut rates again. The June report will be the last big economic report the BoC sees before making a decision on rates at its July 24 meeting, he explained.

“The Bank of Canada is in a bit of a tough spot right now. On the one hand, a look at growth dynamics in Canada—particularly in the labor market—shows that the jobs market in Canada is much weaker than in the U.S., with the Canadian unemployment rate rising in June. Based purely on labor market dynamics, it’s reasonable to think the BoC should cut rates at its next meeting, as it did in early June,” Lin said.

However, a look further under the surface of the June employment report shows that wage pressures actually accelerated last month, he explained, adding that there’s a pretty good connection between wage pressures and inflation in the services sector. “Services inflation was a bit on the sticky side in May as well, making this a complicating factor in the BoC’s upcoming decision,” Lin said.

Ultimately, Lin believes that if the June CPI report shows an easing in core inflation, the BoC will probably be in a good spot to lower borrowing costs again later this month. On the contrary, if core inflation remains stuck at—or slightly reaccelerates from—its current level of 2.7% (year-over-year), he thinks it’s more likely that the BoC will have to defer a second rate cut until September.

Is more stimulus on the way in China?

Kalman and Lin wrapped up the segment by discussing key investor watchpoints for China’s Third Plenum meeting, which takes place July 15-18. The Third Plenum is one of China’s main policy meetings, Lin said, noting that many investors are expecting the Chinese government to unveil additional stimulus measures at the 2024 meeting.

Lin explained that China has announced a 5% GDP (gross domestic product) growth target for the year, which, from his vantage point, looks difficult to achieve without more stimulus. “I think the Chinese government is very committed to hitting this 5% target and is willing to deliver as much stimulus as needed to reach this goal,” Lin said. He expects that additional stimulus measures will be announced at the Third Plenum, and said he’ll be carefully watching to see the type and magnitude of any potential stimulus, as well as what sectors the stimulus is aimed at.

“China’s property market is in a tough spot, as is consumer confidence, so it’ll be interesting to see if any potential stimulus is aimed in either of these directions,” Lin concluded.

Watch

Listen