CPI data for September published yesterday were better than expected. Both the headline and the core data rose by 0.1% m/m against consensus expectations for a 0.2% m/m increase. Compared to the same month 1 year ago, headline CPI rose by 2.3% (consensus estimate at 2.4%), down from 2.7% y/y in August, and core CPI rose by 2.2%, unchanged from August and lower than the 2.3% y/y expected by consensus.
Prices for used cars and trucks posted the biggest decline at -3% m/m while apparel prices posted the biggest increase at 0.9% m/m. Shelter prices rose by 0.2% m/m, in line with a moderation of the last 12 months trend (+3.3% y/y).
The lower than projected inflation data in September confirmed our expectations that inflationary pressures are contained, as we indicated in our last week article “U.S. economy is strong and sustains our bullish case for the U.S. equity markets”. We continue to expect that inflationary pressures will remain contained in the short term as the level of capacity utilization is still below the long term average (78.1% against 80%), even if it is in a clear upward trend, and hourly earnings growth is moderate.
We think that lower than expected September CPI data could bring both the Fed’s members and investors to review their expectations on the monetary policy outlook. At the end of September monetary policy meeting, the Fed members had already revised downward 2019 PCE projection from the 2.1% to 2%. Should the lower than expected inflationary pressures indicated by the September CPI data be confirmed also over the next few months, the Fed could further revise downward its inflation projection in December.
In this scenario, the Fed tightening of monetary policy could end before the Fed Fund rate reaches 3-3.25% at 2019-end and 3.25-3.5% in 2020 as currently projected.
We expect that September CPI data could ease tensions on the U.S. equity and bond markets. After the sell-off in Wednesday, when the S&P 500 lost more than 3%, the equity markets could benefit from expectations that the tightening of monetary policy could be less severe than previously projected, even if the investors focus could turn soon on the quarterly earnings season. Indeed, the release of JPMorgan Q3 results scheduled for today will give the kick-off to the earning season.
Anyway, the S&P 500 (SPY) is now close to the critical level of 2765. A decline below that level must be interpreted as the sign that the latest upward trend begun in March 2016, with the S&P 500 at 2059, could have come to an end.
Lower than projected CPI could also ease tension on the bond markets (TLT, AGG). While the recent increase of the 10 year government bond yields – from 2.98% to 3.17% during the last month – has been mainly due to better than expected economic data, we think that only stronger inflationary pressures could push the yields further upward.
Finally, the U.S. Dollar could also be negatively impacted by inflation data, at least in the short term. Indeed, the CPI data lowered expectation on the yields differential with other Central Banks’ rates, reducing the attractiveness of the U.S Dollar in carry trades. However, in a medium-term perspective, the positive interest rate differential could continue to sustain the U.S. Dollar.
With regards to the EUR/USD exchange rate (FXE), we think that the critical level to see a strong depreciation of the USD is 1.185. Indeed, that level was touched the same day the ECB President Mario Draghi announced the end of the QE program at 2018-end (with a decrease of purchases from EUR30bn per month to EUR15bn per month from September-end) and said that interest rates will remain at current level (Refi rate at -0.4) at least through summer 2019. After that announcement the Euro weakened against the US Dollar, touching a low at 1.1301 in mid-August. We think that a rise above 1.185 will be the signal that the currency market has fully discounted the announcement of the ECB that Euro area rates will remain at current level for another year, at least.
Conclusion: lower than expected September CPI data could bring investors to lower their expectations on the path for Fed’s monetary policy. As a result, tensions on the equity and bond markets could temporarily ease and the U.S. Dollar could weaken even if medium-term perspective remains favorable due to positive interest rate differential.
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