Good morning. The market did not crash on fears of stagflation yesterday, after a colder than anticipated consumer price index report (more on that below). But there is still plenty of tariff uncertainty for investors to contend with. Europe and Canada retaliated against Washington yesterday, after the US’s global aluminium and steel tariffs went into effect; more countries may respond soon. What those responses will be is anyone’s guess, and no one knows whether they will bring President Donald Trump to the negotiating table or invite more retribution. If you had to tariff one US good, what would it be? Email me your pitch: aiden.reiter@ft.com.
CPI
The sound you just heard was the market breathing a sigh of relief. Despite worries that yesterday’s CPI report would come in hot and signal impending stagflation, it came in colder than expected. The headline reading fell from 3 per cent in January to 2.8 per cent in February, and core slid from 3.3 per cent to 3.1 per cent — putting it below December’s relatively cold reading of 3.2:
The turnaround from last month’s hot reading is starker when looking at Unhedged’s preferred measure, the annualised change in month-on-month core CPI:
The annualised change was 2.8 per cent in February, making January’s 5.5 per cent surge look like an anomaly — or, perhaps, a result of the so-called January effect, the occasional inability of the index’s seasonal adjustments to cope with the annual price increases that occur at the start of every year.
Many of the price pressures that pushed last month’s reading up have subsided. Used car and truck price inflation cooled off, as did price rises for shelter and car insurance. Some even reversed: airline fares, which rose 1.2 per cent in January, were down by 4 per cent last month. Equity investors took this all as good news. The S&P 500 finished slightly up, after falling for two consecutive days, and cyclical stocks — specifically info tech and consumer discretionary — posted recoveries.
But before the equity market gets ahead of itself, it must be noted: this was not a particularly good report. By our preferred measure, inflation was higher in February than in December, the last time we said things were cooling off. We’ve been more or less stuck since the autumn, and things could be heating up again. Take shelter inflation, a big part of the index which often lags behind other price categories:
It’s been extremely jumpy for the past few months. Though February’s one-month annualised reading was below the January pick-up, shelter inflation was higher in February than in December and September, when Unhedged and many other pundits called time of death on housing inflation.
There were also some bad numbers lurking in yesterday’s data. The Federal Reserve tends to prefer PCE as an inflation measure over CPI. As Thomas Ryan at Capital Economics said in a recent note, “the components [from CPI] which feed into the Fed’s preferred PCE price index rose more sharply” in February, as compared to January. In particular, computer services and accessories, jewellery, and household appliances came in hotter than expected, as did a few prices linked to services; all three goods categories have very low weightings in CPI, but make up a larger portion of PCE, according to Omair Sharif at Inflation Insights. As a result, many analysts and banks have dialled up their PCE expectations for later this month.
Investors seem attuned to this — though moves in Treasuries and futures markets were muted. Break-even inflation, or the market’s expectation of inflation, ticked up two basis points yesterday, driving a three basis point increase in 10-year Treasury yields. Futures implied rate cuts by the Fed were downgraded, too. More market participants started betting on fewer rate cuts than Wednesday’s consensus of three 25 basis point cuts by year end:
We may have avoided an immediate market meltdown. But the inflation picture is mostly unchanged. We could still see the effects of tariffs passed through to consumers. And, on the whole, prices look hotter than just two months ago. This was just a momentary reprieve of stagflation fears, not a salve. Today’s PPI should also be revealing.
Two Sessions
On Tuesday, China concluded its most important annual gatherings: the National People’s Congress (NPC) and the Chinese People’s Political Consultative Conference (CPPCC), colloquially the “Two Sessions”. The meetings coincide every year, and provide the government an opportunity to present its policy agenda and priorities.
This year’s Two Sessions took place under radically different market circumstances than last year’s. In March 2024, Chinese equities were still in the doldrums, and bonds were in a downward spiral. But this year the market outlook is much rosier. Some animal spirits are still in Chinese equities, after last month’s DeepSeek revelation and the leaderships re-embrace of Alibaba founder Jack Ma:
Hong Kong’s Hang Seng index is above the levels it reached in last September’s rally; the mainland CSI index has been sideways for a few weeks, but is near its September highs, too. Long-tenured Chinese bond yields stopped their years-long fall last month, and rose in the past few weeks:
Most of what came out of the Two Sessions seemed custom-made to support the market trends. The state unveiled a start-up guidance fund of 1tn renminbi ($138bn) to support the AI sector, and, according to various reports, tech was the hottest topic of discussion at both gatherings. The government also doubled down on growth: it set its annual GDP target at 5 per cent and boosted its annual official fiscal deficit allowance from 3 per cent of GDP to 4 per cent to support its stimulus goals. The government also encouraged looser monetary policy, while lowering its official inflation target from 3 per cent to “around” 2 per cent.
Yet, this was all mostly lip service. The market welcomes a further embrace of tech. But there is not much depth to the growth commitments. China’s growth target was 5 per cent last year, too, and it barely scraped by; with incoming stress from US tariffs, Beijing’s tried-and-true strategy of boosting exports will face new challenges.
The increase to the deficit is not really a shift in policy, either. In effect, China shifted its tone towards the national deficit last year, when it said it would stimulate the economy. The official guidance provides a bit more clarity, while still not giving any details on when and how the stimulus will hit. According to Alicia García-Herrero and her team at Natixis, the higher deficit will also not result in the consumption boom that the market has hoped for:
[Given that] the announced increase in the fiscal deficit does not seem to be directed to boosting consumption but rather to supporting the debt restructuring of local governments, one should not expect consumption trends to improve substantially in 2025.
China already pivoted to looser monetary policy last year, too — and it’s not like it has much of a choice. The country is fighting deflation; both headline and core CPI turned negative in February. It needs to lower rates. And changing its inflation target seems more like a concession to reality than an actual policy shift.
Taken together, this does bear some ill omens for the rest of the world, though. To achieve its high-growth goals, the Chinese economy seems set to rely even more on juicing exports; that policymakers are increasingly resigned to deflation suggests Chinese goods could get cheaper for foreign buyers. That puts the country on more of a collision path with rising protectionism in the EU and US.
But, at least for the equity market in the short term, the conference was mostly good news. Outside of stimulus, a Chinese government dedicated to supporting tech and willing to get out of the private sector’s way is really all the country’s equity investors can hope for.
One good read
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