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US headline inflation (CPI) is down to 4% year on year in May from 4.9% a month earlier, with food and energy helping it down, but mostly from base effect (Core CPI that exclude the volatile figures of food and energy is still at 5.3%). We previously mentioned that the base effect will be at its strongest in June, and indeed expectations for June end are at 3%. Meanwhile, the Purchasing Managers’ Index (PMI), after five months of improvements, is cooling down due to a very low reading in the manufacturing component, but also a slight drop in services. The labor market, which is a key indicator that the Fed looks at, is sending mixed signals this month. On the one end, unemployment “shot” up to 3.7% (highest since October 2022), and on the other hand, non-farm payrolls are up for the third straight month. QoQ GDP growth in the US is expected to fall further (consensus +1.1% vs +2.6% last quarter). All negative economic indicators and signs that the cycle is slowing down seem to be ignored as the expectation of a recession is ever fading, or at least being postponed. Even credit spreads have steadily tightened. Monetary policies continue to vary greatly. The Bank of England is having a much harder time combating inflation, and even the base effect is not having an impact. It raised interest rates by half a percent. The European Central Bank rose by 25 basis points to 3.5% with an expected terminal rate of 4%. Eurozone PMI’s remain marginally in expansion territory but the current trend may change that next month. The high expectations placed on China have clearly disappointed, but one good thing that came out is the total normalization of the supply chain, which has helped lower prices and bring inflation down. There is still potential with tourism, but it seems there are very long waiting periods in the administration when it comes to passport renewals. As we have mentioned before, what worries us more is the geopolitical situation in the country. Our summary recommendations With equity markets so healthy this year, we have had a lot of structured products being called, which has naturally increased liquidities. With volatility (VIX) being very low, the conditions are not ideal to structure new products. We are therefore comfortable placing the cash in US T-bills earning about 5% until we see better opportunities. To put it differently, the opportunity cost is minimal compared to when interest rates were at 0. Typically, the summer months are relatively uneventful, but we remain vigilant.
Chart of the month We have compiled a graph comparing the rate hike cycle of 2004-2008 and the 2022-2023 cycle, which shows an interesting visual on where the Fed rate could be headed going forward. Fed rates should remain at that level (between 5 to 5.5%) for a while to have a real effect on the economy. It seems therefore that it is premature to think that the US central bank would decrease rates soon. Source: Bloomberg
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