US inflation decelerated in October, showing some reason for optimism
US inflation undershoot consensus estimates by a wide margin in October. It was only the second (third) time since November 2021 that headline (core) CPI came in below expectations. Specifically, the CPI decelerated to +7.7% year-over-year (yoy) from +8.2% in September. At the same time, the core index decelerated to +6.3% yoy from +6.6% in the previous month.
Unprecedented supply chain disruptions due to the pandemic are easing, core goods inflation has begun to lessen, and commodities have moved lower. Services inflation remains elevated (+0.5% mom), albeit domestic demand is gradually slowing, in response to higher interest rates. As San Francisco Fed President Daly said, “one month of data does not a victory make”, though underlying inflation measures are off their highs on a three-month annualized basis.
In response to the downside inflation surprise, investors lowered their expectations regarding the “terminal” federal funds rate (FFR) by circa 25 basis points to 4.75% - 5% (current: 3.75% - 4%). Monetary policy will become more restrictive, albeit October’s inflation outcome and the cumulative tightening of monetary policy by 375 basis points year-to-date suggest a slower pace of future FFR increases.
US Treasury bonds recorded strong gains, with nominal yields declining by 35 bps wow to 3.81%. Breakeven inflation rates fell by 7 bps wow to 2.41%, whereas 10-Year Treasury Inflation-Protected Securities (TIPS) declined by 28 bps wow to 1.40%.
The S&P500 surged by 6% to 3956 following the inflation announcement, due to expectations for less aggressive interest rate hikes. Asian equities continued to climb higher, with the Hang Seng index up by 25% month-to-date and the CSI300 index higher by 10% for the same period. On the sidelines of the G20 summit, the two leaders (Biden, Xi) agreed that could take concrete actions to put US-China relations back “on the track of steady development.”
The European Commission (EC) anticipates euro area real GDP growth of -0.5% qoq in Q4 and -0.1% qoq in Q1.2023, as higher costs hit firms’ investment plans and the cost-of-living crisis depresses consumption. Higher energy costs have resulted in a loss of income of -3.3% of GDP at the EU level in 2021 and 2022, cumulatively. The EC anticipates real GDP growth of +0.3% in 2023 (versus +1.4% in July’s projections) and +1.5% in 2024, from +3.2% yoy in 2022, viewing the risks as tilted to the downside.
On inflation, the EC places its peak in Q4:2022 at 10.2% yoy on average (10.7% yoy in October), with a gradual deceleration thereafter to 3.7% yoy in Q4:2023. The estimate for 2022 was revised up (compared with July) by 0.9 pps to 8.5% in 2022 and by 2.1 pps to 6.1% for 2023, while the newly introduced projection for 2024 stood at +2.6% (risks viewed as tilted to the upside).
The unwinding of pandemic-related fiscal support is set to offset measures to mitigate the impact from elevated energy prices to firms and households, leading the general government deficit at -3.5% of GDP in 2022 from -5.1% in 2021. Under the assumption that these measures expire early in 2023, the deficit is projected at -3.7% & -3.3% of GDP in 2023 and 2024, respectively