Any sign of inflationary pressure in these data would strengthen bets of earlier-than-estimated tightening of monetary policy by the US Federal Reserve.
Analysts said the US Fed’s underestimating inflation pressure may be real. But whether the Fed will take drastic measures to rein in it will depend on the US jobs market, which still remains fragile.
To recall, Chairman Jerome Powell had in August last year announced a radical shift in the Fed’s inflation goal, saying the US central bank would be looking at inflation ‘averages’ of 2 per cent over time.
In an address to the Jackson Hole symposium, Powell had said the Fed sees maximum employment as a broadbased and inclusive goal. “Fed will assess the shortfalls of employment from maximum level,” he had said.
Recent non-farm payrolls data suggested 2,66,000 job additions in April against expectation of 9,78,000 while March data was revised down to 7,70,000 from 9,16,000 as reported previously.
“The sudden weakening in US job data blunts fears of overheating and inflation risks. The US added just 2,66,000 payrolls in April, nearly one-fourth of what was expected. Unemployment rate increased to 6.1 per cent due to weak job additions and a rise in labour participation rate to 61.7 per cent in April. The effective slack in the labor market is still fairly large at 10.4 per cent of the labor force despite the economy showing strength,” JM Financial said.
“We expect Fed to overlook the temporary spikes. The latest data from the labour market will only reinforce Fed’s current position of continued accommodation; Fed has promised to continue this till 2024,” it added.
CPI inflation for April is seen at 3.6 per cent on year-on-year prices due to a low base, Reuters poll suggested. The core reading, which excludes food and energy costs, is seen at 2.3 per cent. JM Financial sees core inflation rising to a peak of 2.5-2.6 per cent in April-May due to a low base effect and some gains in prices.
Foreign brokerage Nomura has revised its inflation outlook for the US due to three factors: faster-than-expected vaccinations, expansionary fiscal policy supporting demand for Covid-depressed services and pushing up their prices, and an acute semiconductor shortage limiting vehicle production despite growing demand.
“Extremely tight supply of new vehicles is now to last some time, which should push up vehicle prices in the coming quarters. Quick economic reopening seems to be accelerating a reversal of the pandemic-driven urban exodus, helping rent inflation in urban areas bottom earlier than we had expected. However, it is important to note that our upward revisions are largely frontloaded and some transient inflationary pressure, such as higher vehicle prices induced by semiconductor shortages, will likely generate negative payback in 2022,” it said.
The fresh fears of Fed rate hikes gained momentum after the US Treasury Secretary Janet Yellen, who is also the former Fed chair, recently said interest rates will “have to rise somewhat” to make sure our economy does not overheat.
Later, she clarified that she was focusing on the medium-term outlook in terms of the potential impact on the US economy from the Biden administration’s planned mega infrastructure spending. As Jefferies in a recent note pointed out Yellen did actually raise the federal funds rate by 125 bps when she was Fed chair.
“The US is following an economic policy that may lead into some unintended consequences. One of the worries is whether the US inflation can actually be high on a more protracted basis. If that is the case, the Fed has to change its dovish stance. That worry developed very rapidly in the first quarter of the year. We started off the year positively but the narrative has shifted very rapidly into inflation worries,” said Murat Ulgen, Global Head EMs at HSBC.
JM Financial said the US 10-year yield has moderated to sub-1.6 per cent. Along with that, there is a renewed weakening of the Dollar Index to 90 level
“This is a positive combination for equities. The rise in US inflation expectation, led by spike in crude oil prices, will need further weakening in the Dollar Index beyond 90 level as a neutralising factor. Indian equities have underperformed this year amid earlier fears of dollar squeeze and the prevailing Covid-19 spiral. A potential situation of ebbing of Wave-2 worries, weakening of US dollar index and steady risk-free rates can create beneficial conditions for cyclical stocks and sectors. We are mindful of earnings downgrades due to the Wave-2 lockdowns, which may hold back a full-blooded rally,” it said.
