Weekly Market Comment: Sticky lingers?

May 20, 2024

In our latest roundup of developments in financial markets and economies, we consider what to make of a big week for inflation data.

Consumer inflation data dominated economic headlines last week. With “sticky” inflation still on investors’ minds, data releases were carefully analysed for any signs policymakers would back away from their commitments to ease monetary policy this summer.

China consumer prices rose for the third month in a row in April, increasing 0.3% year-on-year, above the forecasts of economists, mostly thanks to a pick-up in energy prices.¹ However, food and general pricing power remains soft, with little sign domestic demand is gaining enough momentum to improve the supply-demand imbalance within China’s economy.

China’s demand problem

The subsequent release of total social financing (TSF) data, a broad measure of credit and liquidity in the economy, highlights the demand problem facing China. TSF shrank by RMB² 200 billion (US$27 billion) in April, the first decline since comparable data began in 2017.³

Year-to-date net issuance of government bonds totals RMB 1.3 trillion, RMB 1 trillion lower than a year ago. Weak demand from corporates and households was evident through declines in loans on a year-on-year basis, and policy banks repaid RMB343 billion in pledged supplementary lending loans to the People’s Bank of China (PBoC). Regulatory and statistical adjustments also had a significant one-off effect on the data, which led M2⁴ money growth to decline to 7.2% year-on-year, the lowest reading on record.

The slow pace of government issuance led the Politburo of the Chinese Communist Party last month to explicitly call for faster execution.⁵ This, coupled with the bleak credit data, led the Ministry of Finance to announce an early start date to the RMB 1 trillion special issuance programme to support the economy, which will start on May 17 and run until mid-November.⁶

The PBoC’s credit growth target is to be in line with real growth and expected changes in prices. In its latest quarterly monetary policy report, the central bank acknowledged constrained credit growth is not due to supply issues, but weak demand.

Last week, the PBoC kept the one-year medium-term lending rate at 2.5%. We expect a further cut of 10 basis points (bps) to policy rates and 50bps cut to the cash reserve ratio over the summer, but the PBoC is clearly putting the emphasis on the government to support the economy through bond issuance, property de-stocking initiatives and other supportive regulatory adjustments. A string of such policies was announced on Friday, including the scrapping of nationwide mortgage-rate floors, and introduction of a land repurchase scheme and an initiative encouraging state-owned enterprises to purchase unsold housing inventories.⁷

Unsurprisingly, the announcement of Chinese stimulus was received positively by investors, with Hong Kong’s Hang Seng equity bourse and Asian high-yield credit market rallying.

‘Will they, won’t they’ saga continues in UK

Elsewhere, the Bank of England (BoE) published the latest private sector regular pay data, a key metric to gauge wage inflation. Wage growth edged down to 5.85% in the first quarter year-on-year, below the BoE’s projection of 6%.⁸ There was also further evidence of a cooling job market with employee payrolls falling 85,000 in April, a significant surprise as the consensus of economists was for 20,000 jobs to be created. Meanwhile, unemployment rose to 4.3%.⁹

The overnight interest rate swap market is currently pricing in a 62% probability of a June cut. Perhaps the latest employment and wage data could be enough to convince the BoE to make that move.

In the Eurozone, there is less ambiguity about when the European Central Bank (ECB) will act, with the latest inflation data pointing to a June cut. Although headline consumer prices held steady at 2.4%, core inflation declined to 2.7% in April from 2.9% in March, while service prices, which the ECB had previously voiced its concern over, dropped to 3.7% having been stuck at 4% for 5 months.

Speaking at the Institute of International Finance summit on May 16, the governor of the Banque de France, François Villeroy de Galhau, said: “The probability of a rate cut by our next meeting on June 6 is, how could I say, significant.”¹⁰

Mixed US data points to further rate cut delay

After three consecutive months of 0.4% prints for core consumer prices in the US, investor expectations of, and the Federal Reserve’s commitment to, a summer rate cut had all but disappeared. At the start of this month, the overnight interest rate swap market had pushed back expectations of a first full cut of 25bps to December; some commentators suggested it wasn’t out of the question the Fed could tighten policy further.¹¹

That still seems highly unlikely, in our view. Core consumer prices in April rose 0.29% over the previous month, a sign the high inflation experienced in Q1 has not carried forward.¹² The Fed will be pleased to see softer shelter inflation, with owners’ equivalent rent easing to 0.42% month-on-month, while declines in car and furniture prices were also notable.

These numbers allowed April core consumer prices on a twelve-month basis to rise by its lowest level in two years, increasing 3.6% year-on-year. Whilst bond bears may highlight super core prices (core services excluding shelter) increased from 4.8% to 4.9% year-on-year, the overall pricing report was supportive for the disinflation trend to resume after stalling in the first quarter. This is especially the case if we combine inflation data with the recent sudden slowdown in jobs growth, decline in consumer spending and confidence, and soft industrial production and housing data.

The net result of the US data download was for the swaps market to move forward the first full 25bps cut in policy rates from December to November. If the weakness in April’s data continues in May, expectations of a first cut by the Fed could be pushed forward to September.

As we noted in last week’s Market Comment, May has so far proved a positive month for financial markets. That trend continued last week. Government bond yields fell, with the long end outperforming; credit spreads tightened, with emerging-market credit outperforming in both investment grade and high-yield buckets; and most commodities and major equity indices ended the week higher.

Chart of the week

Figure 1: Probability of first 25bps rate cut, according to overnight interest-rate swap market

Forecasts mentioned are not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy.

Source: Bloomberg, as of May 17, 2024. For illustrative purposes only.

References

1.National Bureau of Statistics of China, as of May 13, 2024
2.RMB = renminbi
3.Reuters, ‘China stimulus starts with a bond, not a bang,’ as of May 17, 2024
4.M2 money supply = cash in circulation + short-term deposits
5.Reuters, ‘China to step up support for economy,’ as of April 30, 2024
6.Bloomberg, ‘China to Start $138 Billion Bond Sale on Friday to Boost Economy’, as of May 13, 2024
7.Xinhua, ‘China abolishes mortgage floor rates’, as of May 17, 2024
8.Reuters, ‘Mixed UK labour market signals leave BoE on rate cut alert,’ as of May 14, 2024
9.Office for National Statistics, as of May 14, 2024
10.Bloomberg, ‘ECB’s Villeroy Says Probability of June Rate Cut ‘Significant’, as of May 16, 2024
11.Investment News, ‘Fed could hike rates rather than cut them: UBS strategists’, as of April 15, 2024
12.Us Bureau of Labor Statistics, as of May 15, 2024

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co. are as of May 20, 2024, and may change without notice. All data figures are from Bloomberg, as of May 17, 2024, unless otherwise stated.

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