Is Inflation Really a Thing of the Past?
As the weekend approaches, markets are showing a hint of caution. Yesterday, US stock markets experienced a drop, and the 10-year US treasury yield fluctuated as it sought direction, ultimately ending lower. The finance minister of China is expected to deliver a fiscal policy briefing on Saturday, with markets anticipating an announcement of new spending between 2 trillion to 3 trillion yuan ($280-$420 billion). However, concerns persist about whether this will materialize. Meanwhile, the Middle East awaits Israel's response to Iran. On a positive note, the UK's monthly GDP growth for August was 0.2%, a return to positive growth after two months of stagnation.
US CPI Figures Surpass Expectations
US CPI figures released yesterday were higher than anticipated. Headline inflation dropped to 2.4%, surpassing the Bloomberg consensus of 2.3%. Core inflation, on the other hand, rebounded to 3.3%, defying expectations of remaining unchanged at 3.2%. The monthly rates also exceeded predictions, with the headline continuing to rise at 0.2% instead of the expected slowdown to 0.1%. The core rose at 0.3%, contrary to the forecasted slowdown to 0.2%.
The core's services-less-rent-of-shelter inflation, which is closely linked to wage growth and influenced by the Federal Reserve's efforts to balance the labor market, rebounded from 4.3% to 4.4%. It showed a strong acceleration from 0.1% to 0.6% month-on-month. However, shelter inflation fell from 5.2% to 4.9% and eased in month-on-month terms from 0.5% to 0.2%. Despite this, core inflation appears to be somewhat persistent.
Jobless Claims Rise in Early October
Initial jobless claims for the first week of October increased to 258K from 225K the previous week. A significant portion of this increase seems to be weather-related, with states like North Carolina, South Carolina, Florida, and Tennessee that were affected by Hurricane Helene showing large percentage increases. The Federal Reserve is expected to overlook this anomaly. Instead, the Employment Report's depiction of a strong labor market, declining unemployment, and stronger average hourly earnings growth will take precedence. In summary, September witnessed a robust labor market, a rebound in core inflation, and a 50 bps cut by the Fed.
Fed Speakers Remain Optimistic About Inflation
Despite these developments, three Federal Reserve speakers are confident that inflation is moving in the right direction and that the FOMC can continue to cut rates. John Williams of the New York Fed expects a steady downward movement in inflation and supports a gradual shift towards a more neutral monetary policy. Austan Goolsbee of the Chicago Fed noted a clear downward trend in inflation over 12 to 18 months. Thomas Barkin of the Richmond Fed also believes inflation is moving in the right direction. However, Raphael Bostic of the Atlanta Fed expressed comfort with skipping a meeting if data suggests it's appropriate. He also indicated that his September projections would imply one more 25 bps cut this year, following the 50 bps cut in September.
France's 2025 Budget Presented Amid Financial Concerns
French Prime Minister Michel Barnier presented the 2025 budget yesterday. Given France's precarious public finances, the budget was closely scrutinized. Barnier warned that without intervention, next year's deficit could rise to 7% of GDP. He proposed plans to reduce the deficit by EUR60bn next year, approximately 2% of GDP, through broad spending cuts and tax increases on large corporations and affluent individuals.
Despite the detailed plans, Barnier emphasized that the budget draft is a starting point for lawmakers and welcomed amendments that do not undermine the budget's integrity. However, this openness raises concerns that secure cost-saving measures or revenue boosts might be replaced with overly optimistic proposals. Additionally, Barnier's reliance on uncertain opposition backing due to his lack of a parliamentary majority suggests that he may have to significantly dilute his proposals or face another vote of no confidence.
Market Worries Likely to Persist
It is unlikely that this budget will alleviate market concerns. Rating agencies are expected to share this sentiment. Fitch, which currently rates France as AA- with a stable outlook after downgrading the country one notch in April 2023, will review France’s rating after the market closes on October 11.
Given the risks already highlighted by the agency and the comparatively optimistic nature of its earlier projections, a rating downgrade is likely. Although this is not a positive development from a spread perspective, the market seems to be largely pricing in such a move.
Bottom Line
The inflation dragon might not be as dead as some believe. With markets showing caution, US CPI figures surpassing expectations, and jobless claims rising, the economic landscape is complex. Despite this, some Federal Reserve speakers remain optimistic about the direction of inflation. Meanwhile, France's 2025 budget raises concerns and is unlikely to alleviate market worries.
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