Markets largely overlook softer-than-expected US inflation data

Markets largely overlook softer-than-expected US inflation data

Released by the Bureau of Labour Statistics (BLS), the April US CPI inflation report (Consumer Price Index) revealed that despite price pressures rising by less than expected on both the headline and core levels, markets largely shrugged off the release. 

Year-on-year (YY), headline inflation rose by 2.3% (estimate: 2.4%) – the smallest increase since early 2021 and lower than forecast for a third consecutive month – while YY core inflation remained unchanged at 2.8%, with month-on-month (MM) headline and core measures rising by 0.2%, defying estimates of 0.3%. 

According to the BLS, shelter costs accounted for over half of the headline monthly rise, with the shelter index up 0.3% in April. Interestingly, despite the fall in Oil prices (WTI Oil finished April lower by nearly 20%), the energy index rose by 0.7%, buoyed by a rise in electricity and natural gas costs.

Challenging event to trade

The inflation data immediately triggered an upside move in US equity index futures, as well as a moderate drop in the US dollar (USD) and US Treasury yields. Personally, although the lower-than-anticipated reading provided a modest boost to risk, in my opinion, it was a problematic event to trade. Not only has the full impact of tariffs yet to materialise – we still have an average tariff rate of 14% in the US and stagflation risks to contend with – but also, inflation data came in just below the median estimate. I saw no edge here; I was watching the estimate range high and lows, and favoured a trade long on the USD on a higher (hawkish) inflation print, in line with current sentiment and against an overstretched USD to the downside. Alternatively, I was also watching for a long trade in equities on the back of lower (dovish) inflation data, which, again, would have aligned with sentiment. I would not have been comfortable fading the risk rally. 

I also see little in the inflation report to suggest that the US Federal Reserve will alter its ‘wait and see’ approach. Investors are largely unchanged on the rate pricing front, with September’s meeting fully priced in at the moment (-26 basis points [bps]).

Optimistic US-China trade truce boosts risk sentiment

The latest data follows a temporary 90-day reduction of tariffs by the US and China, as the two nations continue their negotiations. This has resulted in the US lowering its levies from 145% to 30% and China reducing its duties from 125% to 10%, effective 14 May. Recession risks have notably declined as a result, providing a boost to the USD and equities, and prompting investors to abandon safe havens. 

It seems that China’s decision to stand firm against US President Donald Trump’s barrage of tariffs paid off, triggering a broad de-escalation in rates, with the US agreeing to nearly all of China’s demands. You may recall that just last week, Trump proposed the idea of lowering Chinese tariffs to 80% from 145%. So, unsurprisingly, this week’s better-than-anticipated announcement injected an immediate risk-on bid across the markets, pushing US and European equity index futures higher, while also supporting a strong bid in the USD, the Chinese yuan (CNY), Oil, and Copper. 

However, things are far from over on the trade war front. For now, it seems the ‘TACO’ trade is underway. I must admit, this was a new acronym for me, and it has nothing to do with Mexican food, standing for ‘Trump Always Chickens Out’. How long the TACO theme will last, though, is anybody’s guess. The main point is that developments are headed in the right direction, and markets are supporting the narrative. 

Written by FP Markets Chief Market Analyst Aaron Hill

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