May inflation preview

After yesterday’s bank holiday in the UK and the US, Tuesday morning has seen a lethargic start; with spreads slightly tighter, equities marginally higher and no clear driver. In spite of what looks like a quiet week ahead, there are a couple of data releases in the coming days that require close attention, these releases could potentially disturb the fragile calm that we are enjoying in the first trading hours of the week. Both of these have to do with inflation.

Europe is up first, with numerous May Consumer Price Index (CPI) releases starting tomorrow in Germany, followed by more CPI data on Thursday and Friday. The week will end with the Eurozone aggregate numbers on Friday. For the most part, expectations for these releases are for a continuation of encouraging month-on-month trends, but with year-on-year figures moving up slightly. We note that month-on-month data reported in Bloomberg consensus is not seasonally adjusted, which results in April’s month-on-month inflation typically being quite high, while May usually brings about a correction. In Germany, month-on-month forecasts are at 0.2%, down from 0.5%. For the rest of countries in the Eurozone expectations are in a similar ballpark as is the decline from April’s data. The Eurozone aggregate as a result is forecasted to come in at 0.2%, down from 0.6. The European Harmonised Index of Consumer Prices year-on-year figures will increase according to Bloomberg consensus from 2.4% to 2.7% in Germany, from 3.3% to 3.7% in Spain, and from 2.4% to 2.6% in France, to name a few.

This is projected to result in a mild increase in the Eurozone aggregate to 2.5%, and a flat core figure at 2.7%. There are some base effects at play, such as a reversal of public transport subsidies in Germany that will contribute to higher inflation, but for the most part trends are likely to be inspiring and will set the scene for the first cut of the cycle by the European Central Bank (ECB) next week. As has been the case for a few months now, the focus will be on services inflation, but we take comfort in ECB President Christine Lagarde’s comments last week, when she said “we have inflation under control”.

In the US, the Bureau of Economic Analysis will publish April’s headline and core Personal Consumption Expenditure (PCE) price index data. After the month-on-month CPI number a couple of weeks ago was a touch better than expected at 0.3%, forecasters projections were revised slightly downwards. Bloomberg consensus speak of flat year-on-year numbers compared to March’s numbers, with headline PCE inflation coming in at 2.7%, whereas the core measure is expected to be unchanged at 2.8%. Even though these figures would still be higher than what the Federal Reserve (Fed) needs to see in order for them to be comfortable in embarking in a sustained cutting cycle, we believe that numbers in line with Bloomberg consensus would be welcomed by markets. We have witnessed a number of upside surprises to inflation year-to-date, which have brought about significant volatility in the US Treasury curve, so we might see a small sight of relief if consensus gets this one right.

We hope to have a quiet week ahead of us, with inflation numbers not changing the picture dramatically for central banks. Monetary policy rates expectations for the remainder of the year look reasonable to us with the ECB forecasted to cut between two and three times and the Fed between one and two times. Consequently, we are in the camp that rates and spreads will continue to trade in their current ranges for now, with some potential volatility as central banks remain 100% data dependant. Carry remains our best friend in this sideways trading environment, and with yields high, there is plenty available, with no need to stretch the risk envelope.