US headline and core consumer inflation come in above expectations

Analysts have incorrectly predicted US inflation for the last four months, with the actual print being above the consensus forecast, highlighting the inherently tricky nature of forecasting inflation.

Year-on-year headline inflation (CPI) in the US increased to 3.5% from 3.4% the month before, while core CPI rose 3.8%, the same as the previous month. Headline CPI has been sticky around 3% for the last six months. The inflation print was primarily driven by energy prices and services inflation.

The inflation print resulted in a material blow-out in US Treasuries, which rose around 30bps (0.3 percentage points), and saw interest rate cut expectations move to the tail-end of the year with only two cuts of 25bps now expected (down from three cuts just last week).

One positive to come out of the inflation print was the month-on-month inflation number, which came in at 0.3%, down from 0.4% the month before, indicating a potential reversal in trend. A month-on-month print of 0.3% implies an annualised rate of inflation of around 3.6%, in line with where inflation currently is.

The key point of comfort is that the upside risks to inflation are greater when month-on-month inflation is above 0.3%. If month-on-month inflation continues to trend downwards, then we would expect inflation to be below current levels.

That said, we would assume that the US Federal Reserve remains uncomfortable with the current rate of inflation, which is well above the central bank target of 2%.

It is also worth highlighting that shelter inflation, which makes up around 30% of the headline CPI basket and around 45% of the core CPI basket, continued to trend down, coming in at 5.7% in March. US headline CPI, excluding shelter inflation is sitting at 2.3%, just above the 2% central bank target.  Sustained declines in shelter inflation imply that headline and core CPI should continue to trend towards 2%.

Another key data point has been the Institute of Supply Management (ISM) services index – prices paid series, which is typically well correlated with inflation four months later. The ISM services – prices paid data point came out at 53.4, a significant collapse from the previous month’s reading of over 60. The print implies that inflation should come under downward pressure in four months. 

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US producer inflation also re-accelerated in March

US 12-month producer prices rose from 1.6% the month before to 2.1%. While the acceleration is of concern, we would need to monitor the trend to ascertain the directionality of producer inflation.

Producer inflation is typically a leading indicator of consumer inflation, and weak producer inflation of around 2% implies that consumer inflation should be around 2% in six months.

There are therefore a couple of reasons to not be overly concerned with the latest consumer inflation print, and the initial market moves may have been an over-reaction. 

Global inflation is on a downward trajectory

From a global inflation perspective, on aggregate global inflation is on a downward trajectory. Another good set of news out of this inflation reporting cycle is that inflation globally tended to surprise on the downside (below expectations).

Global producer prices are similarly enjoying the same downward trend.

And inflation should not be a problem in one year. For developed economies, consensus forecasts suggest inflation should be slightly above the 2% central bank target. For developing economies, inflation is either within the central bank target range or below (eg. China). 

Risks to US export growth

Over the last few weeks, we have spent time covering the various risks to GDP growth in the US, and this week we conclude the final piece of the puzzle, net exports.

Export growth in the US is typically positively correlated with GDP growth.

About 17% of US exports go to the EU, and if you add the UK, this goes up to around 25%. Economic growth is expected to be slow (to +0.5%) in the EU, which should impact consumption. The UK is similarly expected to record growth of 0.4%.

Weak exports imply weak GDP growth in the US, and this is one risk to US GDP growth this year.

Import growth in the US is also typically positively correlated with GDP growth.

Ordinarily, imports should be a function of domestic demand while exports should be a function of external demand. In the case of the US, both imports and exports are positively correlated with US GDP growth.

One possible reason is that US GDP makes up around 25% of world GDP.

Weaker global growth (estimated to slow from 3.1% in 2023 to 2.8% in 2024) implies that import growth should be weak in the US.

So, both imports and exports are screening negative for US GDP growth in the US.

Exports and imports are also both negatively correlated with the dollar, meaning a weak or strong dollar has the opposite effect on both imports and exports. However, the explanatory power of the dollar on exports and imports is weak.

A priori reasoning suggests that a weaker currency would be good for exports and bad for imports. We would have also expected the terms of trade to have a significant explanatory power on imports and exports.

This is adding another complexity in determining what may drive imports and exports in 2024.

Our view that the dollar should weaken in 2024 implies that both imports and exports should thus do well.

So, the weaker trade dynamics as a function of weaker economic growth are somewhat offset by the terms of trade dynamics. 

SA inflation in focus

South Africa’s consumer inflation numbers for March are set to be released this week. We see upside risks to inflation, primarily driven by a weaker rand dollar exchange rate and rising Brent crude pricing.

Our analysis suggests that food inflation should not be an issue at this point. However, we remain cognisant of the short-term risks around food inflation as a function of recent drought conditions in South Africa, issues with water infrastructure, and some other rising production costs.

Inflation for South Africa, according to our modelling, should not breach the central bank target over the near term and should gradually trend towards the centre point of the central bank target range of 4.5%. 

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