Fabian Estevez

The Consumer Price Index (CPI) experienced an increase of 0.4% this month, mirroring the rise seen in February but exceeding the anticipated 0.3% forecast. Consequently, this has elevated the annual inflation rate to 3.5%, compared to 3.2% in February, and slightly above the projected 3.4%.Upon examining the core components of the CPI, which exclude the volatile food and energy sectors, we observed a 0.4% increase, surpassing the expected 0.3%. This has resulted in an annual rate of 3.8%. The primary drivers of this month’s inflationary pressures were identified in the shelter and gasoline indices, which collectively accounted for over half of the monthly increase in the all-items index.

The energy sector experienced a notable revival, registering a 1.1% increase for the month, which corresponds to a 2.1% increase on an annual basis. Particularly, gasoline prices witnessed a monthly increase of 1.7%, culminating in a 1.3% annual growth. Concurrently, the food sector saw a modest uptick of 0.1% in March, amounting to an annual increase of 2.2%. It is significant to highlight that the cost of dining out surged by 0.3% on a monthly basis, resulting in a 4.2% annual escalation, while the prices for groceries remained unchanged. Moreover, shelter expenses sustained their ascending trend, making a substantial contribution to the monthly inflation surge with a 0.4% increase in March, equating to an annual rise of 5.7%.

The inflation rate has shown a notable acceleration since the beginning of the year, with persistent challenges in mitigating housing and shelter costs, further exacerbated by the recent pressures from the energy sector due to geopolitical tensions in the Middle East. In light of the March policy meeting, the Federal Reserve, along with several of its officials, emphasized the ongoing need to address inflation concerns. As such, it is anticipated that we will persist in a higher interest rate environment for an extended period before considering any potential reductions. Presently, the market consensus for the June policy meeting has significantly shifted, with a 79% expectation for maintaining the current rate, diverging from previous anticipations of an initial rate reduction.

Change (%) in the last twelve months in CPI and Core CPI

Source: U.S. Bureau of Labor Statistics

Monthly change (%) in CPI

Source: U.S. Bureau of Labor Statistics

Setting itself apart from other developed country central banks, the Bank of Japan (BoJ) decided to raise the short-term interest rate from -0.1% to a range of 0.0% – 0.1% in recent weeks. This move ended a 17-year era of negative interest rates, a situation unprecedented in recent history. Additionally, it ended its control of the yield curve (although it will continue to buy sovereign bonds) and its program of buying ETFs and real estate investment trusts (REITs).

In this context, the question arises: What structural changes have occurred in the country’s macroeconomic environment? After many years of fighting deflation, Japan has been experiencing inflation above the BoJ’s 2% target since April 2022, driven by wage increases not seen in decades, the rebound in the economy, and cost increases that local companies have been able to pass on to consumers after a long period of stable and declining prices. This mix of factors has allowed company profits to rebound. There is speculation that this change in the course of monetary policy is considered a legacy of the policies introduced by Japan’s late Prime Minister Shinzo Abe with the inception of ‘Abenomics’ over a decade ago to combat two decades of a deflationary environment. Much of the optimism that the country’s equities have registered in just over a year would be supported by all of these factors and the region’s longstanding underexposure.

It is worth noting that the reaction within the financial markets was moderate, with Japanese government bond yields experiencing minimal change, the Japanese yen (JPY) experiencing some depreciation, and Japanese equities showing little change.

Finally, the question is whether the Bank of Japan will raise rates again in 2024, and if so, what will be the pace of further increase? Currently, market expectations suggest that the short-term rate could reach 0.25% by the end of the year. However, the most likely scenario points to a broadly accommodative policy stance in the near term, with gradual rate hikes. To provide further clarity, the central bank will be watching the release of the April economic report, the conclusion of the spring wage negotiations, and the inflation release (April 19) before its next monetary policy meeting on April 26. In summary, this move by the Bank of Japan, although symbolic, should be interpreted as a first step on a long road to monetary policy normalization still to come.

MSCI Japan Index cumulative price returns (%)

* Cumulative price yields shown from December 31, 1980 through February 29, 2024 in Japanese yen.

 Source: Capital Group

Quarterly earnings season will begin in the coming weeks. The most recent report indicates that the analyst consensus anticipates annual earnings growth for the S&P 500 of 3.4% (YoY) for the first quarter of the year. If confirmed, this could mark the third consecutive quarter of YoY earnings growth for companies. However, this estimate is lower than the 5.7% YoY increase that analysts estimated at the beginning of the quarter.

Six of the eleven sectors are projected to report YoY earnings growth, led by the utilities, technology, communication services and consumer discretionary sectors. In detail, it highlights the expected 20.3% YoY earnings growth in the technology sector, where NVIDIA, Microsoft and Micron Technology have been the main contributors to this increase. In the case of the consumer discretionary sector, Amazon.com and cruise companies stand out as the main factors behind the expected growth of 15.3% YoY. On the other hand, four sectors are expected to report a YoY decline in earnings, led by the energy and materials sectors in the face of lower commodity prices. Finally, the industrial sector is expected to report an unchanged (0.0%) YoY earnings performance. 

At the revenue or sales level, the consensus forecasts a 3.6% YoY increase, which is below the average revenue growth of the last 5 years (+6.9%) and below the average revenue growth of the last 10 years (+5.0%). Nonetheless, if the 3.6% expected revenue growth were to materialize, revenues would accumulate fourteen quarters of positive growth. With this combination of factors, the net income margin for the quarter would be 11.6%, practically the same as in 1Q23, although better than the 11.5% average of the last five years.

Analysts continue to project that earnings and revenues for the full year could reach increases in the order of 10.9% and 5.1%, respectively. 

As is customary, JP Morgan will kick off on April 12; therefore, investors’ focus will be on the development of the season, amid a high level of optimism for the AI boom and the prospect that the first interest rate cutbacks could occur later this year. 

S&P 500: expected earnings growth for the 1Q24

Source: FacSet

The Federal Reserve (FED) made the unanimous and widely anticipated market decision to once again leave the target range for the federal funds rate unchanged at 5.25% – 5.50%, its highest level in the last 22 years. Since July 2023, the FED has not changed the target range. This decision comes in the context of accelerating inflation, which reached 3.2% annually in February (3.8% annually excluding the most volatile components such as food and energy), along with an increase of 275,000 jobs (vs. 198,000 estimated).

In this context, the statement described that the latest employment indicators have shown a solid performance, while inflation remains elevated despite its notable reduction over the last year. In addition, the statement reiterated that the Committee does not expect it to be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%, while it will continue to monitor the implications of incoming information for its future decisions. 

On the other hand, the FED updated its macroeconomic perspectives, reaffirming that there will be 3 cutbacks of 25 basis points (bps) in the remainder of the year, unchanged compared to December’s estimate. This would bring the federal funds rate to 4.6% from its current average level of 5.4%. By 2025, it could end at 3.9% from 3.6%. As for the economic scenario, the new estimate underwent a notable upward revision, with GDP growth of 2.1% from the previously estimated 1.4% by the close of 2024. By 2025, strength could be maintained with growth of 2% from the 1.8% previously forecast. These scenarios place the economy at growth very close to its long-term potential of around 2%. The unemployment rate was unchanged for both years at around 4%. However, estimated core inflation (excluding volatile components such as food and energy), as measured by the Core PCE, rebounded slightly to 2.6% from 2.4%, while the estimate for 2025 remained at 2.2%.

During his press conference, Jerome Powell confirmed that the federal funds rate has peaked. In addition, he reaffirmed the commitment to return inflation to its long-term target of 2% and expressed confidence that eventually we will begin to see less pressure related to services and housing costs, which have been affecting core inflation. However, Powell noted that the timing of when this may occur is difficult to estimate. 

FED Indicators Update (March vs. December)

Source: Federal Reserve

With monetary policy generating much anticipation in the macroeconomic and financial outlook for this year, it is inevitable that investors will wonder how the presidential election might influence the Federal Open Market Committee (FOMC). Historically, the Federal Reserve (Fed) has not stood on the sidelines during election years but has continued to pursue its dual mandate of price stability and maximum employment, always seeking to maintain its independence from politics. Since 1980, the Fed has adjusted rates in every election year, except in 2012 when rates were at zero due to the recovery from the financial crisis.

The Fed lowered rates in five election years and raised them in five others. In 1980, the Fed raised rates by 1% (the federal funds rate, Fed Funds, had hovered around 17% earlier that year). It then cut back rates by 5.5% between February and July as the economy entered a recession. However, it resumed rate hikes to combat double-digit inflation between August and November (the Fed Funds closed that year around 19%). In 1984, the Fed raised rates by 2.25% in the second quarter as inflation rose and unemployment declined, only to reduce them by 3.5% in the fourth quarter as inflation stabilized. In 1988, the Fed began the year with modest rate cutbacks, then raised rates through August and resumed hikes after the election.

On the other hand, in 1992, it concluded the consecutive rate reductions initiated at the beginning of the 1990-1991 recession and implemented its last reduction in January 1996 after the soft landing that followed the 1994-1995 hiking cycle. Also, the Fed concluded its May 2000 hiking cycle, which began in 1999, noting that the stock market was peaking in March 2000.

In 2016, the Fed waited until after the election to hike once in December and continued with rate hikes in 2017 and 2018. It is also relevant that the Fed entered new monetary policy cycles that required an accelerated reaction, as in the severe recessions of 2008 and 2020, respectively.

In this context, it can be seen that the Fed continued to pursue its dual mandate goal, regardless of the political issue. This year is expected to follow a similar pattern, with a potential decrease in the Fed Funds rate as inflation approaches the 2% target, and the economy experiences a ‘soft landing.’

Note: A soft landing in the economic cycle is the process by which an economy moves from accelerated growth to slow growth, potentially reaching a stagnation phase, although it avoids going into recession.

Changes in monetary policy in an election year.

Net change in the federal funds rate, %.

Source: JP Morgan