Adam Skerry, head of inflation, abrdn and Maximilien Macmillan, senior investment director, asset allocation & research, abrdn, discuss US inflation, possible rate cuts and what this means for a multi-asset approach to investing.
Does US Inflation Justify a FED Cut?
US CPI peaked in June 2022 at 9.1% and is now almost 6% lower. With Jerome Powell acknowledging policy is currently tight, what inflationary forces are preventing the FED from cutting rates?
– Momentum. The most recent release for February had headline CPI increasing by 0.4% month on month, the largest monthly gain in six months, taking the headline year on year CPI to 3.2%, up from 3.1% in January, which itself was an upside surprise.
– Supercore. The Fed’s preferred measure of core services ex-rents (“supercore” inflation) grew by 0.5% m/m in February, down from the exceptionally high 0.9% m/m in January, but demonstrated upward pressure from a range of drivers which left the year on year rate unchanged at 4.3% having been as low as 3.75% in October 2023.
– Energy. Energy goods prices (ie gasoline) rose in February having dropped for the previous four months in a row. Brent crude has hit levels not seen since October 2023 and the Blomberg commodity index is at a four month high.
– Goods. Core goods prices had their first positive month (+0.1% m/m) in the past nine, having played a key role in the disinflation story to date.
– Services. Core services were +0.5% m/m in February but the 3 month annualised rate is at 6.2% compared to 5.2% in November, demonstrating renewed upward momentum.
– Core. Core CPI is now running at an annualised 3 month rate of 4.2%, outside of the covid spike, the highest level since 1991. This has contributed to the Fed’s preferred core PCE measure, where the three month annualised rate of 3.5% is uncomfortably high.
– Expectations. Five year inflation swaps have ground higher since the start of the year with the market pricing in a higher for longer inflation profile, breaking above 2.5% for the first time since November last year.
How does this impact a multi-asset approach?
Equities are showing signs, much as they did last summer, of reaching a point of saturation. Since the Fed came to the (presumed) end of their rate hiking cycle, 10yr US inflation swaps above 2.6% and rising have seen equities derate. The same is happening today.
When growth is the marginal driver, equities can perform while bonds sell off, but today we are experiencing two more corrosive marginal drivers:
1. A hawkish policy shock: the delayed reaction to disappointing inflation prints, leading to a sharp real rate sell off in real rates
2. A supply shock: an escalation in the geopolitical tension in the middle east contributing to higher oil and higher inflation swaps
The supply shock, of course, only fuels expectations of a more hawkish setting of policy. The result is the usual pattern of returns, most synthetically described as a tightening of financial conditions. This is epitomised by a simultaneous sell off in bonds and equities, and a rally in dollars and commodities.
Implications & expectations
All eyes remain on Fed speakers, particularly Chair Powell, in forthcoming statements for more signs of caution over the inflationary threat. May is unlikely to see a rate cut but it could lay the ground ahead of the June meeting, which the market still prices for the first move. Resilient growth and robust employment markets with inflation still lingering at uncomfortable levels could well set the tone for a higher for longer rate profile.
We expect the financial conditions to tighten as much as is required to bring inflation swaps back under control, after which we think that the growth momentum underpinning risk assets will be sufficient for the rally to resume. In the meantime, we focus on protecting portfolios from a continuation of these risks (excessive inflationary pressures) until we see signs of a moderation.
About Adam Skerry
Adam is Head of Inflation and Co-Manager of the Macro Fixed Income Fund within abrdn. He joined Standard Life Investments in March 2011, working in the Real Returns Team. Adam is responsible for the Macro Fixed Income Fund which invests across a range of bond and foreign exchange markets, as well as being a lead manager of both UK and Global Inflation Linked Bond portfolios. He began his career in 1998 at PricewaterhouseCoopers and then moved onto other investment management roles at Henderson Global Investors, Saxon Financial and Baring Asset Management. Adam graduated with a BA (Hons) in Modern History & Economics from the University of Manchester. He also holds the Investment Management Certificate (IMC) and is an Associate Member of the UK Society Investment Professionals.
About Max Macmillan
Max is a Senior Investment Director in Multi-Asset at abrdn, focusing on Tactical and Strategic Asset Allocation. In this role, he is also responsible for managing their Unconstrained capability. Previously he was an Investment Manager on the Global Fixed Income team, focusing on Asset Allocation in the Global Aggregate and Absolute Return funds. He joined the company in 2012, working in London with the Global Macro and EMD teams, before spending three years in Sydney managing Interest Rate and FX risk with Australian FI. Earlier he gained experience working in Mergers and Acquisitions and Debt Capital Markets at J.P. Morgan in Paris and London. Max holds postgraduate degrees from Cambridge University and Sciences Po Paris earned in Economics (GDip, Distinction) and Finance (Masters, Cum Laude) respectively. His undergraduate degree was in Physics and Philosophy from Kings College London.
