Daily Comment (April 11, 2024)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equities are mixed after the weaker-than-expected PPI report. In a Champions League upset, Barcelona edged past PSG in Paris, and took a 1-goal lead into the return leg. Today’s Comment examines how rising inflation (CPI) impacts interest rates, explores the increase in defense spending due to growing geopolitical tensions, and analyzes the hints of possible easing by the ECB as part of a wider trend among developed central banks.

Rate Cut Expectations: Stronger-than-expected March inflation and hawkish FOMC meetings have led to a rethink on rate cuts.

  • Inflation surged in March, exceeding forecasts, and year-over-year consumer prices jumped to 3.5% (up from 3.2% in February). Core CPI, excluding volatile food and energy, also climbed to 3.8%, driven by rising costs in housing, healthcare, and car insurance. This robust report dampens hopes for the Fed achieving its 2% target, as indicated in recent meeting minutes. The minutes also reveal a divided committee, where some members fear geopolitical tensions and relaxed financial conditions could further inflate prices. In contrast, others see the potential for downward pressure from technological advancements and continued immigration.
  • Recent data exposes unexpected inflation trends. Despite the Federal Reserve’s anticipation of falling housing costs, shelter inflation remains stubbornly high. The three-month annualized rate rose to a worrying 7.11% in March, a significant departure from the expected disinflation. Furthermore, inflation isn’t limited to housing. Core services, excluding rent, have also seen substantial increases, rising 9.3% at an annualized rate over the past three months. This unexpected increase in core services, which are sensitive to wages, suggests a tight labor market, which could fuel broader inflationary pressures.

  • March CPI data complicates the Fed’s policy decisions. Their preferred gauge, core PCE inflation, is near their target (2.78% vs 2.50% target range). However, headline CPI inflation, the more widely followed measure, remains above 3.5%. This divergence creates a challenge. The higher CPI number suggests the Fed may now need to hold interest rates steady for a longer period than initially anticipated to avoid accusations of partisanship in an election year. Although a summer rate cut isn’t entirely off the table, its likelihood has diminished significantly.

Defense Spending Splurge: Rising global tensions are prompting governments to ramp up defense spending in a bid to deter potential adversaries.

  • The intensifying tensions in both the Middle East and Asia emphasize the critical importance of resilient supply chains. Recognizing the emerging alliance between Russia, China, and Iran, US allies are joining forces to bolster their military capacities, aiming to deter potential aggression. This collaborative effort is yielding early successes, as shown in the groundbreaking military drone radar developed by a notable French defense company. As geopolitical rifts deepen, the imperative for security investment grows, underscoring the importance for countries to support global defense companies in safeguarding collective defense interests.

 ECB’s Cautious Pivot: The European Central Bank decided to hold rates steady as it prioritizes economic growth over the inflation fight.

  • Global monetary policy is in uncharted territory as central banks are deviating from the Federal Reserve’s cautious approach. This divergence, coupled with ongoing doubts about the need for US rate cuts given its economic resilience and robust labor markets, could significantly strengthen the dollar. A stronger greenback could pose a double challenge for economies reliant on dollar-priced imports as it would exacerbate inflationary pressures, forcing them to reconsider planned rate cuts. Additionally, a robust US economy might lead their central banks to maintain higher interest rates than desired, potentially hindering domestic growth.

Other News:  Manhattan rent dips hint at a stabilizing market, but high housing costs remain a hurdle for the central bank in achieving its 2% inflation target. Facing a persistent Russian offensive, Ukraine confronts growing challenges in maintaining momentum. Switzerland will hold a peace conference to mediate the Ukrainian/Russian crisis.

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