US Inflation Test

US stocks ended modestly higher last week, reflecting the net effect of mixed forces.

On the one hand, the minutes from the latest US Federal Reserve meeting were reassuring, and failed to provide the signal the markets had been fearing that the Fed would raise rates three further times this year rather than two. Indeed, although core US inflation has now moved back up to around 2%, Fed members generally saw little risk that it would accelerate a lot further anytime soon, and were prepared to tolerate inflation at or a little higher than current levels – without an accelerated interest rate tightening schedule – given inflation has been sub-2% for an extended period.

Another key event last week was a drop back in oil prices following talk that OPEC and Russia could increase production a little to make up for losses in Venezuela and, potentially, Iran. Although the immediate effect of weaker oil prices is to hurt energy stocks, it’s actually a bullish development for equities more generally. Indeed, the good news is that OPEC/Russia – who we must accept can now effectively set global prices through adjusting supply – are conscious of the need not to let prices get too high too fast at the risk of overly hurting demand.

The other negative news last week was the apparent cancellation of US-North Korean talks, which hurt US stocks on Friday. But with hopes raised again over the weekend that talks were “back on again”, local and Asian markets may well shrug off Friday’s weak lead from Wall Street.

Confirmation that the US-North Korea talks are moving ahead should be greeted positively by US markets once they resume trading after their Monday memorial day holiday.

Other key developments this week will be US inflation updates, with the private consumption expenditure (PCE) deflator on Thursday and average-hourly earnings (AHE) as part of the payrolls report on Friday. Market estimates suggest the core PCE (i.e. excluding food and energy) will be benign, with annual inflation easing from 1.9% to 1.8%. Similarly, the market anticipates only a modest uptick in annual AHE growth from 2.6% to 2.7%. If the market is right – and I expect these reports will be fairly benign – these should be reassuring for both equity and bond markets.

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In Australia, we get further updates on the economy which are likely to show a still fairly restrained outlook. Home building approvals are likely to drop back a little on Wednesday after last month’s strength – confirming activity is still trending down, albeit slowly. The key takeaway from Thursday’s private capital expenditure report will be the degree to which there’s a further upgrade (hopefully at least modest!) to non-mining investment intentions for the coming financial year, given continued upbeat business confidence indicators.

Bigger picture: with US President Donald Trump approaching his geopolitical battles with some flexibility, US inflation indicators still fairly benign (as evident with US 10-year bond yields still failing to push much past 3%), and oil prices potentially past their peak, the outlook for global equities – and hence local stocks – remains encouraging.

Written By: David Bassanese