April 16, 2024
Audience: intermediate to advanced investing knowledge
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We learnt last week that US inflation rate accelerated for a second straight month to 3.5% in March 2024, highest since Sep '23 and compared to 3.2% in February, while core CPI moved from 3.75% to 3.8% - not a pretty reading.
Inflation was expected to slowly but steadily come under control. And it's not.
Will rate cuts ever happen in 2024?
The immediate result of higher inflation has been a re-pricing of rate cut expectations in the US: from 3x to only 1x (in October) in 2024 - see the first green triangle in the chart below.
The US economy remains strong and its standout performance is making the US inflation problem harder to solve, as just commented by the International Monetary Fund. In fact, the IMF upgraded today (Tuesday 16 Apr) its forecast for US economic growth to close at 2.7% this year, or 0.6% higher than what it predicted in January.
Looking at geopolitics, Iran's attack against Israel did not rattle markets too much (perhaps thanks to the success of their Dome shield) but has certainly not helped to push oil prices down (from around USD 85/b) - another factor to justify new inflation worries over the next few weeks and months.
Europe instead seem to remain on track for 3x cuts between July and December 2024.
Fixed income headaches
Higher inflation has pushed US Treasury yields higher.
We can see in the chart above, for example, that US 2 year Treasuries have moved 20bps higher in a week, touching 4.92% as we type. Higher yields are not ideal when the entire asset management industry predicted in January a great year for fixed income. Funny, isn't it?
If investment portfolios with longer duration are surely suffering this year, a short-duration strategy (yes to income, no to rate sensitivity and capital losses when yields rise) continues to be appropriate for 2024. Actually, the possibility to lock-in over 5% in US cash-markets, or just about 5% with maturities of 2 years create an interesting income opportunity that was not available since fall 2023.
In comparison, if EU rates have been volatile, they returned back to where they were before the latest US inflation reading (Germany at 2.9% over 2 years, Spain at 3.1%, Italy at 3.5%).
Equity markets are fading
Despite expecting a healthy set of earnings, equity markets - having priced-that-in already - have retraced down in the past few days on inflation woes, with both the US and Europe down around 2% since last week.
Looking at the US as proxy example, we can appreciate the change in sentiment in the more recent investors' preference for defensive stocks.
Hard to read the future, but let's say that if we avoid (even) wider geopolitical tensions in 2024, then a healthy set of expected earnings will support stocks while bond prices at discount should invite more flows. All of this would be true if the bad US inflation reading in March was a one-off.
We suspect it might not be.
Rising inflation for longer would invite to further reduce duration in our fixed income portfolios, move the attention from weaker HY issuers to stronger credits able to withstand higher interest expenses and upcoming maturity walls, continue to bet on healthy stock markets (that benefit from nominal growth).
Here's probably a good summary to what is going on, in one picture (via Andreas Steno Larsen):
