Ten days ago, stocks and bonds rebounded after the publication of reassuring figures on the rise in US prices, which reinforced hopes of a rate cut by the Fed.
The consumer price index (CPI) excluding food and energy rose 0.16% in May. This is its weakest increase since August 2021. The annual core inflation rate fell to 3.4%, the lowest in three years, compared to 3.6% the previous month. Meanwhile, headline CPI rose just 0.01% month-on-month thanks to lower gasoline prices.
Producer price inflation in the United States also showed signs of slowing: it stood at -0.2% month-on-month in May, after the 0.5% increase recorded in April.
Fed Caution
During its monetary policy meeting, the Fed left its rates unchanged as expected. In her press release, she welcomed “the further modest progress made towards the 2% inflation target set by her committee”.
Nevertheless, the Fed has been cautious about the pace of rate cuts. According to the graph of Fed officials’ rate projections (“dot plot”), they are now only counting on a single cut (median forecast) by the end of the year, compared to three in March when the latest projections have been published. The Fed also revised upwards its inflation forecast for the end of 2024, to 2.6% compared to 2.4% previously.
What does that mean?
These recent figures reinforce the idea that the trend towards decreasing inflation in the United States, which had stopped in the first quarter, has resumed. This news should prevail over the Fed’s “dot plot” which, by its own admission, is a forecast conditional on the evolution of the data. It’s also worth noting that the median projection for rate cuts in 2025 is now four rate cuts, up from three previously, with four more cuts planned for 2026.
Fed Chairman Jerome Powell said the move in the dot plot was mainly attributable to the Fed’s raising inflation forecasts. However, he also admitted that the Fed’s inflation forecasts were “with some caution” and that most of its members had not changed their policy rate projections after the release of the CPI in May, even if they had already read about it.
Slowdown in prices of essential services
According to UBS Research, the detailed inflation figures were even more favorable than the headline figures. In particular, Jerome Powell highlighted the importance of the slowdown in the prices of essential services excluding housing, which fell by 0.04%, a first since September 2021.
This category includes prices for services such as leisure, hospitality, insurance and childcare, which typically have a large wage component. The slowdown in this indicator could indicate that the deceleration of wages is helping to alleviate inflationary pressure in these categories.
And hope of a slowdown in rental prices
The rental equivalent of property owners, which has recently been one of the main drivers of inflation, is certainly recording a slight acceleration. Nevertheless, there is hope that its increase will slow, judging by high-frequency data which highlights a decrease in rents.
As lease contracts are generally signed for one or two years, it takes time for official data to reflect this. However, a decline in this important component of inflation should only be a matter of time.
No overheating of the economy in sight
The inflation figures should remove the specter of an overheating of the economy, which resurfaced after the publication of employment figures in May in the United States, notably the 272,000 job creations (much more than the 185,000 predicted by economists).
The figures are also consistent with recent data indicating a gradual slowdown in activity, notably those relating to job vacancies and labor turnover (JOLTS report – Job Openings and Labor Turnover Survey), ISM manufacturing index, real estate data and credit card balances.
How to invest?
The outcome of the Fed meeting and the inflation figures support the idea that the American economy is heading towards a soft landing, which should allow the central bank to lower its rates by 50 percentage points. basis this year, most likely from its September meeting.
Therefore, more than ever, four basic strategies will be recommended to investors.
- Buy quality bonds
Government bonds face an unfavorable backdrop this year as investors have become more cautious about the speed and timing of Fed rate cuts. The markets have undoubtedly become too pessimistic.
Even if the United States is a long way behind Europe in terms of lowering key rates, American Treasury bonds should not take long to incorporate new easing measures once the cycle begins and American yields rise. ten years should end the year at 3.85%.
Therefore, investors would do well to capture bond yields, which are currently attractive. We will also appreciate investment grade corporate bonds, even if selectivity is required due to the weakness of credit spreads.
The European Central Bank, Bank of Canada, Bank of Sweden and Swiss National Bank have already cut rates and it now appears likely that the Fed will follow suit in September.
Therefore, the return on liquidity should soon decrease.
In these conditions, investors holding cash or monetary investments, or those whose term deposits are maturing, should consider managing their liquidity by building a portfolio of bonds with staggered maturities or a balanced portfolio composed of stocks and of bonds. Another possibility: invest in structured products which offer some capital protection.
- Seize opportunities by taking advantage of a spreading rebound
There is optimism about the prospects for the technology sector, whose global profits are expected to increase by 20% this year, notably driven by artificial intelligence (AI).
We are also seeing many opportunities on the equity markets thanks to a rebound that is spreading, particularly among Chinese stocks, American small caps, the cream of European companies and long-term beneficiaries of disruptive innovation.
Small caps are particularly well placed to benefit from falling key rates because they borrow more at variable rates than larger companies. They are lagging behind the general rebound in the stock market and therefore present a historically significant discount compared to large caps.
- Diversify using alternative assets
Amid moderating economic growth and potential market volatility, investors would do well to consider dedicating a portion of their portfolio to alternative assets.
An allocation to hedge funds can reduce portfolio volatility when stock and bond markets move in tandem. Unlisted assets can provide another source of return to further diversify portfolios. Investors should be aware of the risks inherent in this asset class, including illiquidity and the complexity of certain strategies.
