This market update centres around inflation, particularly within the US and China. As well as this, wages and energy prices are discussed. The key points from this week’s newsflow are:
US inflation in two charts: June headline inflation rose just +0.18% m/m to 2.97% y/y (May: 4.13%) – second chart. This was a much bigger drop than expected. The even more important Core inflation print (first chart) rose just +0.16% m/m to 4.83% y/y (May: 5.33%). A sharp decline in airfares lowered Core inflation by -0.06% while used car prices are estimated to have fallen some -0.50% while shelter slowed modestly further with rent +0.46% and OER (owners’ equivalent rent) +0.45%. The drop in used car prices could just be the start of more to come based on the -10% drop in auction prices.
…..it got better on the US inflation front: June Headline PPI (input) inflation was almost unchanged rising just +0.1% m/m to 0.1% y/y. Services inflation rose 0.2% boosted by a 5.4% surge in deposit services (incl. current and savings accounts). Motel accommodation rose 2.3%, hospital in-patient care rose 0.6% and airline tickets rebounded 1.1%. Portfolio management fees fell -0.3%. Road freight transport fell -2.1% to -13.7% y/y. Goods prices were unchanged while energy prices rebounded 0.7%.
China’s inflation: paints a very different story. June Headline inflation unexpectedly edged down to 0.0% y/y and marks the lowest reading since Feb. 2021. Core inflation also edged down to 0.4% y/y. The main driver was non-food (-0.6% m/m) with the cost of transport falling even further (-6.5%). Food inflation gained the most in three months (+2.3%) hit by a rebound in fresh vegetables and eggs. This was despite a sharp fall in pork prices. Food is some 32% of the inflation basket by weight with residence at 17%. June’s producer (input) price inflation fell at its fastest pace in over seven years at -5.4% y/y (May: -4.6% y/y). The PBoC (its CB) stated “it has ample policy leeway to address unforeseen challenges and changes….” And hinted at utilizing tools such as the RRR (Reserve Requirement Ratio) and MTLF (Medium Term Lending Facility) to shore up liquidity. The 2Q GDP release is due next week – it’s expected to be strong even though it benefits from coming off a low base.
Source: Department of Labor, Goldman Sachs Global Investment Research
What’s next?
For the next couple of quarters, we are looking at the following economic environment:
US inflation in two charts: June headline inflation rose just +0.18% m/m to 2.97% y/y (May: 4.13%) – second chart. This was a much bigger drop than expected. The even more important Core inflation print (first chart) rose just +0.16% m/m to 4.83% y/y (May: 5.33%). A sharp decline in airfares lowered Core inflation by -0.06% while used car prices are estimated to have fallen some -0.50% while shelter slowed modestly further with rent +0.46% and OER (owners’ equivalent rent) +0.45%. The drop in used car prices could just be the start of more to come based on the -10% drop in auction prices.
Labour markets will remain tight. This is evidenced by employment levels. The degree of softening so far is questionable and, in any event, not compelling enough for Central Banks (CBs) that we are out of the woods yet.
Wages will continue to rise – at varying speeds. For example, in the UK, wage growth surprised yet again to the upside and is rising at 7.3% y/y. The BoE’s preferred, private sector wage growth index is rising at an even faster rate of 7.7% y/y. Both are within reach of inflation (8.7% y/y). In the US, wage growth is 5.74% y/y, well ahead of both nominal & core inflation. In the Euro Area as a whole, wages are rising 4.6% y/y vs inflation of 5.5% y/y. The latter has been dropping fast (it was 6.1% y/y the month before). The two will soon be in line. In Germany, wages are declining at the rate of -2.3% y/y though this is a big improvement on the month before (-5.4% y/y) and reflects how hard hit the country was from the Ukraine crisis. In Japan, inflation is running at 3.2% y/y. The food component is running at 8.60% y/y. Wage growth is running at 2.5% y/y (the highest it reached was 4.1% y/y in December 2022). The trend is upward and with the Government trying to encourage wage hikes amongst corporates, the two are not far apart.
Speaking of inflation, the downward pressure will continue driven primarily by further energy inflation declines but also some core inflation elements easing further. However, the disparity between the headline and core rates will remain large and persistent for some time and of concern to both Governments and CBs. Both the latter will be very keen to see headline inflation stabilise at a low level (around 3%) so they can press the pause button on further rate hikes. The big balancing trick now is how to ensure the mortgage market doesn’t topple over. This is not a problem in regions like the US and Europe (mortgages are fixed for multi-year durations) but is an issue for others (UK, Australia). That said, the BoE is of the view the UK economy is proving resilient. There are some 29mn homeowners in the UK and only 11mn have mortgages. Of these 11mn, some 800,000 (=7%) are expected to refinance into more expensive mortgages during this 2nd Half; a further 1.6mn (=15%) will do so in 2024. Anyone refinancing now is paying an extra £220 pm in interest payments. By 2026, an estimated 1mn will be paying £500 pm more….but 2026 is far down the line. Who’s to say rates will be the same then as they are now? Let’s stick with this year and the problem is not so acute. For next year, we will have to see. If the rate outlook is one of cuts, then mortgage rates will reprice downwards very quickly.
Industrial activity will start to tick up. The inventory hangover from Covid days has not yet cleared. There’s still a lot of stock to get through and another two quarters will be needed to clear it, just in time for Christmas.
Energy prices will remain subdued – partly because the general risk-on theme means a weakening US$ (the US$ and commodity prices share an inverse relationship) but also because of rising shale production from the US (and other non-OPEC countries ) that’s helping to offset OPEC production cuts. Any increase in the demand side is unlikely to lead to sharp rises in the price of oil.
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