Key takeaways
- While U.S. inflation is accelerating, elsewhere in the world it’s surprising to the downside, suggesting other major central banks could cut rates first.
- The good news is that equities still rise and the dollar tends to weaken in these instances, as long as the Fed eventually follows.
- A more worrisome development would be if the Fed increases rates while other parts of the world are easing policy.
Inflation paths have changed
At the beginning of the year, the Fed appeared to be on a clear path to easing policy. Inflation data was coming in less than anticipated, with markets pricing in around 150 bp of rate cuts this year.
But a few ugly inflation reports since then, including this latest one for March, coupled with a stronger-than-expected labor market, has reduced some clarity on the Fed’s path.
On the other hand, in many other parts of the developed world, such as the Eurozone, Canada, and Australia, inflation has been surprising to the downside. Upside surprises remain positive in the U.K., but much less so compared to recent months.
This disparity in the inflation trend was also evident in the latest global PMIs, which saw global input and output price growth pick up markedly in the U.S., but slow on aggregate in the rest of the world.
Not the usual leader
While we still expect the Fed to ease policy this year, the other major developed market central banks may do so before the Fed. In recent history, this has been highly unusual. Since the early 1980s, the Fed has led all but one (in 1998) of the easing cycles among major developed market central banks. The good news is that equities still rise and the dollar tends to weaken in these instances, as long as the Fed eventually follows.
A more worrisome development would be if the Fed increases rates while other parts
of the world are easing policy. This is even a more unusual circumstance. However, we
did see this happen in 2015. In that case, we saw the dollar strengthen and equity markets down a year later.
Inflation surprises have turned positive in the U.S., according to the Citigroup Inflation Surprise Index. Meanwhile, inflation surprises are negative or have become less positive among most other major developed economies.
The March global PMI report saw both the input and output prices indexes accelerate in March. However, the gain was led by the U.S., as shown in the chart at left. Excluding the U.S., global inflation growth eased.
The Fed has initiated almost all rate-cut cycles (except for 1998) since the early 1980s.
Prior to that, the lead in rate hike cycles was more varied, occasionally led by the Bank of
England or the Bundesbank.
As shown in the chart below, equities have on average been up by around the same
amount a year after a first rate cut whether the Fed or another central bank initiated the
cycle.
The dollar tends to fall when the Fed embarks on a rate-cut cycle whether the Fed
goes first or another central bank. However, the decline has tended to be even larger a
year later when the Fed has lagged other central banks.
For global asset allocation, NDR recommends an overweight allocation to stocks and underweight allocations to bonds and cash. Our recommendations are in-line with our Global Balanced Account Model.
Equity Allocation
U.S.
Our U.S. asset allocation recommendation is 70% stocks (15% overweight), 30% bonds (5% underweight), and 0% cash (10% underweight). On an absolute basis, we are overweight the S&P 500. The technical deterioration during the July – October correction has been replaced with some of the strongest breadth readings this cycle. We favor small-caps over large-caps and are neutral on Growth versus Value.
INTERNATIONAL
We are overweight the U.S., underweight the U.K. and Pacific ex. Japan, and marketweight on all other regions.
Macro
ECONOMY
The global economy has shown notable resilience, with recession chances waning. Risks include monetary and fiscal policy uncertainty, sticky inflation, and easing Chinese growth.
FIXED INCOME
We raised our exposure to 110% of benchmark duration, and recommend curve steepeners. We are overweight MBS and underweight CMBS and ABS. We are marketweight everything else.
GOLD
We are currently bullish.
DOLLAR
We are currently bearish.
Alejandra Grindal is chief economist and Patrick Ayers is senior analyst for Ned Davis Research Group.
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