Thought of the day

Investors’ next main focal point will be today’s release of US consumer price inflation (CPI) data for March. The February release reported an unexpected 0.4% month-over-month rise in both headline and core inflation that complicated the outlook and discomforted both traders and the Federal Reserve alike.

Since then, generally stronger-than-anticipated activity and jobs data have pushed US Treasury yields up toward their highest levels since November, as traders have scaled back expectations of how much the Federal Reserve will cut rates this year. Markets are now pricing 67 basis points of rate reductions for 2024, compared with around 150 basis points in early January.

A Reuters poll of economists suggests that headline and core inflation will slow to 0.3% month-over-month rates in March. The headline rate could increase to 3.4% year-over-year on base and statistical effects (from 3.2% previously), while core inflation is expected to moderate by one-tenth to 3.7%.

Investors and policymakers will undoubtedly pore over details of the report. Three areas under scrutiny may include signs that start-of-year price effects in certain categories were exclusively seasonal; indications that real-world moderation in rents is feeding into owner equivalent rent calculations; and overall trends in services inflation to gauge whole-economy price pressures.

But regardless of how the market responds to a single inflation data point, we believe investors should stay the course and build portfolios with positions that can perform well in a variety of inflation scenarios over the second quarter and beyond:

Speedier disinflation increases the allure of quality bonds. If a lower-than-expected print adds to evidence from the March jobs report of a slowdown in annual average hourly earnings growth, markets may move to price for at least the same number of rate cuts as indicated in the Fed dot plot, if not more. Our base case is that the March CPI print will show a smaller monthly increase than in January and February. And overall, our base case remains that the Fed should be in a position to cut rates around mid-year for a total of 75bps of rate reductions in 2024. So, we forecast the 10-year US Treasury yield to fall to 3.5% by March of next year. This creates the potential for capital gains in quality bonds like government debt and investment grade corporate issuers, more so if markets fear an adverse “hard landing” scenario that precipitates even steeper Fed cuts to provide accommodative monetary policy. CIO has a most preferred view on highly rated fixed income.

Continued steady disinflation supports diversified stock investment and a fundamental focus. We especially like technology opportunities spurred by the development and application of AI, as well as opportunities beyond tech that benefit from the steady growth and disinflation backdrop in the US. The share prices of smaller US companies can perform especially well in an environment of moderating inflation and future rate cuts—these firms typically issue a greater share of floating-rate debt compared to larger firms, so they benefit disproportionately from falling borrowing costs.

A “hot” inflation print may spur demand for hedges, including oil. A CPI print that substantially exceeds market expectations would likely lead investors to expect “higher-for-longer” US rates and also potentially raise their demand for perceived inflation hedges. CIO has a most preferred view on oil, given it benefits from supply/demand imbalances and geopolitical tensions. We recently upgraded our year-end Brent crude oil price target to USD 87/bbl (from USD 82/bbl previously), driven by an increase to our 2024 oil demand growth estimates and a reduction in our OPEC+ crude production projection for the second quarter. We also think a firmer inflation print may support investments that benefit from a “bear steepening” of the yield curve—the phenomenon where longer-term yields rise more quickly than short-term ones.