U.S. Inflation Hits Six Year Highs, Geopolitical Risks Linger


Heading into the third quarter, the focus will likely remain on the Federal Reserve tightening monetary policy with a more bullish outlook for 2018 (given higher inflation and low unemployment) coupled with geopolitical risks and tariff tensions all continuing to fuel market volatility.

The second quarter ended on high notes. Ten-year Treasury yields closed the quarter higher at 2.847%, although it reached a seven-year high at 3.109% during the quarter. The S&P 500 also closed on the upside and was trading around 2,718 at the time of this writing. Geopolitical risks throughout the quarter fueled oil prices, with WTI crude trading around $74.16.

On the flip side, emerging markets equities and currencies ended the quarter on a low, given the increasing trade tensions and as higher U.S. interest rates and thereby a stronger USD hurt EM. The MSCI EM stock index fell nearly 9% over the quarter. The Argentine peso, Brazilian real and Turkish lira were among the hardest hit relative to the USD.

I. Fed Official Eric Rosengren shared his economic outlook in an interview. Key takeaways included:

  • How year-end annual economic growth rates may slightly beat the Fed’s expectation of 3%.
  • Concerns and uncertainty regarding the macroeconomic impact of trade tensions, in particular how the disruption manifests itself to supply chains and pricing impact.
  • Acknowledgment that inflation is in line with the Fed’s target and low unemployment numbers underlie the Fed’s path to gradually remove accommodation.
  • Comfortable with two more rate hikes this year.
  • Rich commercial real estate prices given the current stage in the economic cycle. Devaluations usually occur when an economic cycle comes to an end where valuations are rich and vacant properties increase.
  • While he does not think a downturn may be imminent, he is worried about the current stage of the economic cycle and its imbalances if the economy is pushed too hard.

II. U.S. Economic Data

  • Inflation: U.S. inflation posted an annual rise in May at 2.3% – the biggest y-o-y increase since March 2012. It is the first time since early 2017 that the inflation rate surpassed the Fed’s inflation target rate of 2%. Further, the core personal consumption expenditures index (that excludes energy and food) came in at 2%, a rate not seen since April 2012.
  • GDP: The U.S. economy slowed more than previously estimated (Q1 GDP revised lower from 2.2% to 2%) on the back of slowing consumer spending levels, which neared five-year lows. Consumer spending accounts for about two-thirds of the country’s economy. Nevertheless, some market practitioners have a more bullish outlook on Q2 GDP data (some expect a percentage as high as 5.3%) given the Trump administration’s $1.5 trillion fiscal stimuli has yet to filter into the data.

IV. Other

  • Eurozone inflation also posted a rise at 2% higher than last June, the jump can largely be attributed to higher energy prices. The core gauge, excluding energy and food, dropped to 1% in June from 1.1% in May. ECB President, Mario Draghi, noted a possible pick-up in inflation by year end at the central bank’s last press conference. The softer core inflation data further fuels the ECB’s likelihood of keeping rates on hold until the summer of 2019.
  • Eurozone countries came to an agreement regarding immigration policy. The Euro and Italian bonds rallied on the back of more stringent considerations for immigrants, although details have yet to be ironed out.

This week…

Despite the shorter trading week in the U.S. given the fourth of July holiday, a slew of data is scheduled to be released this week both domestic and abroad. Given the recent trade tensions, a number releases reflect the private sector’s perspective on the current climate of trade manufacturing and services around the globe (i.e. Markit data). Other key releases include:

  • Eurozone unemployment (Monday)
  • AUD central bank rate decision (Tuesday)
  • The release of FOMC minutes (Thursday)
  • U.S. June unemployment (Friday)
  • CAD unemployment data (Friday)

Key U.S. Data includes:

Markit manufacturing PMI (Monday), ISM manufacturing PMI, ISM prices paid, construction spending, redbook index (Tuesday), ISM NY index, factory order, total vehicle sales, API weekly crude oil stock, MBA mortgage applications (Wednesday), ADP unemployment change (Thursday), markit services PMI, markit PMI composite, ISM non-manufacturing PMI, U.S. June unemployment data (Friday), Baker Hughes U.S. Oil Rig count.

Overseas Economic Data includes: Caixin CNY PMI (Monday), Swiss retail sales, Spain/German/French/Italian/EUR markit manufacturing PMI, Italian unemployment, GBP markit manufacturing PMI, EUR unemployment, NZD business confidence, AUD inflation data (Tuesday), AUD building permits, AUD central bank rate decision, GBP PMI, EUR PPI, EUR retail sales, CAD markit PMI, AUD retail sales (Wednesday), AUD trade data, Caixin CNY services PMI, Spain/Italy/German/Euro markit services PMI, German/EUR markit PMI composite, GBP markit PMI composite, German factory orders (Thursday), Swiss CPI, JP,Y overall household spending, JPY leading economic index (Friday), German industrial production, CAD trade data, CAD unemployment data.

Good Luck and Happy 4th of July!!