European CPI ticks higher, a warning of inflation pressure to come

Eurozone inflation data for February has surprised to the upside, with the headline CPI estimate falling to 2.6%, which is higher than the 2.5% expected, the monthly rate also rose by 0.6%, this is an increase of 1% compared to January, when the monthly rate of inflation was -0.4%. Core prices didn’t ease by as much as expected last month, they grew at a 3.1% rate, compared with 2.9% expected. It has now been 26 months since core inflation in the currency bloc was below 3%. After yesterday’s rally in stock markets, which was fuelled by the annual US core PCE rate moderating in January, European data for February is a wake-up call that inflation pressures still exist.

Why central banks will maintain their cautious tone

The moderation in CPI and PCE in the Eurozone and the US, caused some traders to question if US and Europe will cut interest rates sooner and faster than what is currently priced in. There was a slight increase in expectations for a May rate cut from the Federal Reserve after Thursday’s PCE data, there is currently a 23.57% chance of a rate cut in May, on Wednesday this was closer to 20%. As we mentioned on Thursday, while annual rates of inflation have been moderating in line with expectations, monthly rates have been rising, and the monthly rate of the core PCE was at its highest level for a year, largely driven by service inflation. This suggests that there is inflation pressure building in the US and European economies. While central banks remain data dependent, we need to get other pieces of the puzzle before we can get a clearer picture of what central bankers will do next. This means that next week’s ECB meeting and US labour market report will be crucial.

ECB quandary could boost asset price volatility

The market reaction to the European data has been mild. EUR/USD initially ticked higher, but has since moderated, and this pair is now trying to hold onto the 1.08 handle. German bond yields have also fallen on the back of this data, even though inflation ticked higher. The 2-year German Bund yield is now at its lowest level of the morning, although we expect some volatility as the latest economic data supports a cautious ECB when they meet next week. The German 2-year yield has risen 50 basis points so far this year, so it is normal for there to be some stickiness around the 2.9% level. European stocks have also taken a knock on the back of the inflation data, with the Eurostoxx 600 index erasing some gains, although it remains higher on the day. This data means that there is now less certainty about what the ECB could say at their meeting next week, which increases the chance of market volatility. 1-week volatility for EUR/USD has surged higher on Friday and is now at its highest level since 6^th Feb.

When rare market events become the norm

Elsewhere, US stock markets reached another record high on Thursday, and price action on Friday suggests that there is no slowdown in stock prices at the start of a new month. The Nikkei is closing in on the key 40,000 level and the MSCI Asia index has racked up its sixth straight week of gains. Usually, these are rare market events, however, the strength of the upside momentum of this global risk rally means that rare events are becoming the norm.

The FTSE MIB and the FTSE 100 are leading the charge in Europe, although US stock market futures have turned lower. However, we expect another round of analyst upgrades for the S&P 500 for 2024, as US and global risk sentiment remains strong.

Why the FTSE 100 may struggle

It is worth noting that at the start of the year, Barclays and UBS had predicted that the S&P 500 would end the 2024 at 4800 and 4850, respectively. While there is still some way to go yet, conditions may get better for stocks as we move through 2024, with lower interest rates expected, and analysts are currently expecting four consecutive quarters of revenue growth for the S&P 500. The FTSE 100 has had a good start to the month; however, it is worth noting that analysts expect return on equity to decline in 2024 and 2025. For 2023, ROE for the FTSE 100 was15.80, this is expected to fall to 14.69 in 2024, and to fall to 14.19 in 2025. Thus, analysts expect UK companies to become less profitable this year and next, which could keep a lid on FTSE 100 gains in the coming months. This also compares poorly with the SPX, where ROE is expected to rise to 18.61 this year, and 18.97 next year.