US inflation: 4pc on the horizon, but 2pc still a way off | Pendal Group
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US inflation: 4pc on the horizon, but 2pc still a way off

After ‘mildly encouraging’ US inflation data, markets believe the Fed is done with rate hikes. But they may be over-estimating the potential for cuts, says Pendal’s TIM HEXT

US INFLATION data out Wednesday was mildly encouraging.

Headline CPI was 0.4% for the month and 4.9% annual. If we exclude food and energy the monthly number was also 0.4% — though slightly higher annually at 5.5%.

All this was as expected.

The mild encouragement in the latest data — which saw yields fall and equities rally — came from something called “core services inflation excluding rent”.

Excluding rent gives us a better idea of the inflation pulse outside housing. It’s important because rents tend to swamp the CPI, accounting for 41 per cent.

This measure came in at 0.11% — the smallest monthly rise since July last year.

For the first time there are signs we may settle at a pace closer to the Fed’s 2% target.

Rents

Rents are always slow to move, but can be somewhat predicted.

This is because CPI rents cover the stock of rents, not new rentals. However, with 2-3% monthly turnover in rentals they eventually catch up with new rents.

This is good news for the US, since new rents (measured by the Zillow index) are falling.

In Australia, though, the opposite is true.

New rents are rising — and we can expect overall rents to keep rising in the Australian CPI.

However, rents only make up 6% of the CPI in Australia.

We measure housing costs more widely than the US, with new dwelling costs included.

Overall housing is 25% of the CPI in Australia against 41% in the US.

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Pendal’s Income and Fixed Interest funds

Market Implications

Markets now believe the Fed is done with hiking.

Without a new surge in employment or inflation this looks fair.

After all, the US cash rate has now caught up with the Fed’s own expectation of where they see rates topping out, known as the Fed Dots.

US markets cannot stand still though, so they’ve factored in 75 basis points of cuts.

This will be a test for the Fed’s resolve on inflation.

Even though the pace of inflation will fall soon to around 0.2-0.3% a month, it will still leave inflation above the Fed’s 2% target.

Without a significant credit crunch or slowdown this does not leave room for rate cuts.

Perhaps the market is saying there is a 50% chance of no moves and 50% chance of 1.5% lower rates, because a recession would mean larger and quicker rate cuts.

On average there is a six-month lag between the last hike and first cut in the US.

For now we remain rangebound in yields with a small trend lower.

Inflation data should be friendly going forward but employment data may take some time to moderate.


About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.

Find out more about Pendal’s fixed interest strategies here


About Pendal Group

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

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