MacroMetrics: Winds of Change

This time last month, our Macro Strategy U.S. inflation surprise index was in positive territory, but markets were firmly focused on the growth narrative, and our hard data surprise index was at its weakest since the start of the pandemic. The broad consensus was that the Fed would start easing by summer. Fast forward a few weeks, and inflation surprises remain high, but hard data surprises have completely reversed direction and sit back near the turn-of-year highs. Add to that the stalled improvement in our U.S. inflation diffusion index, and it's possible to understand why the market has returned to its favourite theme of 2023, inflation.

TD Securities Data Surprise Indexes – U.S.

So inflation data in the next few months will matter. For the March U.S. Personal Consumption Expenditures (CPE) data, our macro strategy team expect a 0.3% m/m gain in the Core PCE deflator, in line with the market. A meaningful upside surprise risks shifting the narrative even further into hawkish territory, and markets may start to doubt the Fed's conviction to cut at all. April's Consumer Price Index (CPI) data is unlikely to help reinforce the cutting narrative, either: and we look for a 0.3% m/m gain in both Core and Headline CPI when it's released next month. Sure, that's a touch weaker than March, but again, any upside surprises will have significant implications for markets and could materially push out or diminish our baseline forecast of gradual curve steepening and challenge our weaker dollar narrative.

Diffusion Index: Share of CPI Basket Items Growing by More than 4% Y/Y

Europe Cuts First?

The big question that comes out of our macro strategy forecast for delayed Fed cuts is whether Europe can cut rates first. In short, we believe so. Central banks (even the Bank of Canada) generally don't cut rates because the Fed cuts, but G10 central banks do often respond to common global shocks. War on the doorstep of an energy importer like Europe has a different impact on inflation than if it were far away from a major energy producer, like the U.S. So central banks in the two regions may well diverge over short periods of time.

This is reflected to some degree in our inflation forecasts. We expect U.S. core inflation to remain much stickier in 2024 than elsewhere, in part because the U.S. is experiencing more demand-driven inflation, while Europe is coming out of a bout of supply-driven inflation. We expect inflation in the U.K to be at or below the 2% target from April until Q4 2024, while in the euro area, the trend continues steadily toward target through the year (at the same time as labour markets appear to have turned a corner). Both President Lagarde and Governor Bailey have spoken out about the difference between European and U.S. inflation drivers recently.

Markets See Rate Cuts Accelerating in Q3

At the same time, growth fundamentals remain encouraging in Europe. Could it be that policymakers in Europe have in fact engineered a softer landing than the U.S. (which may be over-heating), with inflation returning to target sooner, rate cuts coming faster, and growth back to trend?

Will Geopolitical Risks Get in the Way?

There are growing geopolitical risks the world over. Tensions in Ukraine, the Middle East, South-East Asia, and with over half the global population voting this year, mean that at the end of the year, there's a good chance the world won't look the same as we expect today. Policymakers will need to juggle these risks against their desire to cut rates, and the optimal path of policy is not clear. Data will continue to lead central banks down their cutting path, but events may well get in the way.