The hotter-than-expected US inflation report for March, which followed yet another robust jobs report, has raised the risk of higher-for-longer rates. Given this, Standard Chartered in its outlook said it sees increased risk of the Fed delaying its first rate cut to H2 (instead of June). If the first Fed rate cut is delayed, it would also reduce the chance of three rate cuts this year as the Fed is expected to be reluctant to make aggressive changes to policy ahead of November’s presidential elections. Meanwhile, the ECB has signalled an increased chance that it will initiate rate cuts this summer as inflation in the region subsides.
Based on these developments, SC said it sees an opportunity to add US inflation hedges, such as energy sector equities and inflation-protected bonds. The house would also look to add to US technology and communications sector equities on dips as it anticipates the sectors to deliver strong Q1 earnings. Among bonds, European government and investment grade corporate bonds look increasingly attractive as it expects the ECB to start cutting rates in June. And has also initiated bearish EUR ideas.
Inflation uptrend: The latest US inflation report belies the Fed’s expectations that the rebound in inflation in January and February was a blip. Headline and core inflation in March both beat estimates and services inflation excluding energy and housing prices, which the Fed calls ‘supercore’ inflation, has been on an uptrend since late last year (based on 3-month and 6-month annualised rates). Shelter inflation is proving to be stickier than expected as the job market remains robust, while transportation-related services’ inflation (especially auto insurance) has been on an uptrend.
Overall, it appears that the robust job market, increasingly sustained by a surge in immigration over the past year, is causing the inflation upsurge. The Fed, acutely aware of the repeated bouts of inflation in the 1970s, is likely to be reluctant to cut rates until it sees clear signs of a resumption in last year’s disinflationary trend. Money markets are now pricing 1-2 rate cuts this year, with expectations of the first cut pushed back further to November (from September).
Investment implications:
Inflation hedges: The hot inflation report should add tailwinds to some inflation hedges such as Treasury inflation protected bonds. SC says its other inflation hedge, energy sector equities, carries a risk of a near-term pullback due to stretched positioning. The house say it would look to buy on dips.
High quality bonds: European government bonds look particularly attractive after the recent surge in yields, given slowing Euro area inflation, which stands in contrast with the US. It looks increasingly likely that the ECB will cut rates in June, before the Fed. In general, Developed Market investment grade government and corporate bonds look increasingly attractive. For US 10-year government bonds, the yield needs to rise more than 55bps from here and thus set a record high for the post-pandemic cycle (above the October 2023 high of 4.99%) for investors to lose money. For US investment grade corporate bonds, the benchmark yield needs to rise more than 80bps from here for investors to lose money.
Opportunities in equities: In equities, all 6 opportunistic ideas have delivered positive returns since they were initiated it said (US energy, technology and communications sectors; India large-cap; China non-financial high dividend SOE basket of A- and H-shares). The house says it would use any pullbacks to accumulate US technology and communications sectors as it expects strong Q1 earnings for these sectors.
Near-term bearish on EUR: To capitalise on rising expectations of ECB rate cuts starting in June, the house has recently initiated bearish EUR/NZD and EUR/CHF ideas
