Global Weekly Commentary
Why deflation is dead
- We see rising U.S. inflation over the near term, and prefer Treasury Inflation Protected Securities (TIPS) over Treasuries.
- The odds of a Federal Reserve (Fed) rate increase this summer rose following the release of hawkish Fed meeting minutes.
- Future Fed policy will be in the spotlight again this week, with data about the U.S. economy closely watched.
U.S. inflation has been picking up, following a prolonged period of subdued price rises. We see signs of rising inflation over the short term, with deflation no longer an imminent risk.
The U.S. Consumer Price Index (CPI) in April posted its largest increase since February 2013. The inflation upturn is even more pronounced in forward-looking prices-paid surveys, such as the Institute for Supply Management’s Prices Index, our analysis suggests. A greater number of purchasing manager survey respondents reported paying more for products and services in March and April, as the chart above shows.
A preference for TIPS
Energy supply-demand fundamentals are turning from a headwind into a tailwind for inflation. Oil supply has tightened, and demand is picking up, primarily out of China and India. This suggests current prices look increasingly sustainable, unless we get a significant reopening of idled shale-oil production. It points to energy’s downward pressures on inflation beginning to subside, in line with the view expressed in hawkish Fed meeting minutes released last week.
Our analysis suggests rising U.S. inflation pressures will persist, as factory-gate price increases are passed on to consumers. It is not just the rebound in energy prices pushing inflation higher. An appreciating U.S. dollar is abating as a headwind. Prices of more stable service-based components of the CPI are also rising. Wages, too, are moderately increasing, as are survey-based consumer inflation expectations.
Bottom line: The odds of the Fed increasing rates this summer have increased, although we see only one to two rate increases this year amid slow U.S. growth. We are cautious on duration, but rising inflation means owning TIPS in lieu of nominal Treasuries can be an important hedge for fixed income portfolios. Longer term TIPS valuations look attractive, pricing in just 1.4% inflation well into the next decade.
|May 23||U.S. Markit PMI Manufacturing; eurozone PMI|
|May 25||U.S. Markit PMI Services|
|May 26||U.S. Durable Goods Orders|
|May 26-27||G7 Summit hosted by Japan|
|May 27||Fed Chair Janet Yellen speaks at Harvard University|
Fed policy will again be in the spotlight this week given a recent strong run of U.S. economic data and the FOMC’s hawkish meeting minutes. Reports on U.S. durable goods orders and the manufacturing and services PMI this week will shed light on the strength of a second-quarter growth pickup – and whether a June Fed rate increase is likely. Yet the Fed’s decision may hinge on external developments; its June 14-15 policy meeting comes just a week ahead of a key U.K. referendum on EU membership.
Elsewhere, Japan is expected to announce fiscal stimulus at the G7 Summit, and possibly a decision on whether to delay a consumption tax hike slated for next April.
- Federal Open Market Committee (FOMC) meeting minutes suggested the Fed is contemplating a June rate increase. Markets are now pricing in a roughly 30% probability of this scenario.
- U.S. Treasuries, global equities and commodities prices retreated, while the U.S. dollar rose on expectations of Fed tightening.
- Japanese stocks rallied as the yen weakened. Domestic growth beat expectations.
Weekly and 12-Month performance of selected assets
Asset class views
Views from a U.S. dollar perspective over a three-month horizon
Insights and Resources