Little Relief in Current Data

The February inflation data was better than expected, and so was the January JOLTS report. However, both have diminished relevance amid the onslaught of policy changes. Forward-looking indicators are more troublesome.

• US: Current Data Less Relevant Amid Changes
  
• Canada: Further Rate Cuts Are On The Way
  
• Japan: Wage Momentum Remains Intact
  
• Spotlight on Next Week

Weekly Highlights

US: Current Data Less Relevant Amid Changes

The February inflation data was, on the margin, better than expected, and so was the January JOLTS report. However, both data points have diminished relevance amid the onslaught of policy changes—tariffs and government layoffs—that have the potential to shift the tenor considerably in coming months. Forward looking indicators like the Michigan consumer sentiment index highlight the risks: consumer confidence continues to plummet, and inflation expectations are surging.

Be that as it may, we’ll still happily take a lower than expected inflation print over the opposite. Overall and core (excluding food and energy) prices rose 0.2% m/m, allowing the corresponding measures of inflation to cool by two tenths each, to 2.8% and 3.1%, respectively. The good news is that for core inflation this was the lowest print since April 2021. The bad news is that there will be little (if any) further progress in the next few months.

Food and energy prices were well behaved, up 0.2% m/m each. Services rose 0.3% m/m, easing back from January’s hot 0.5% monthly gain. This allowed services inflation to ease one tenth to 4.1% y/y, the lowest level since December 2021. Not every category within services moved lower, but rent of shelter (down a tenth to 4.3% y/y) and transportation services (down 2.2 percentage points to 6.1%) helped offset slight acceleration in medical care services and other services (each category accelerated 0.3 ppt to 3.0% y/y and 2.8% y/y, respectively). A sizable 4.0% m/m drop in airfares explained the retreat in transportation services inflation. While airlines have recently commented on soft demand conditions, it seems unlikely that such soft readings persist.

New vehicle prices eased 0.1% m/m while used car vehicle prices rose 0.9% m/m. This marked the sixth consecutive month of rising used vehicle prices, following a string of six consecutive declines prior. At this point, used vehicle price inflation in the CPI sits marginally above the y/y increase in the Manheim auction price index, so the “catch-up” period should be over.

There is simply too much chaos around tariff policy now to be able to confidently assess ultimate impact on US inflation. We are working on an assumption of 40-50 bp ultimate impact on core PCE inflation, which still seems reasonable despite the aggressive opening gambit by the US administration on the trade front. We still believe there is room for the Fed to cut three times this year, a view we had maintained since Q4 last year and that had since been in and out of favor in the marketplace. We look for the next cut in June, which would mark a 6-month pause since the last reduction in December. Next week’s FOMC Summary of Economic Projections (SEP) will likely maintain the 2-cut median, but we expect increased dispersion within the “dot plot”.

Job openings ticked higher in January (to 7.74 million from 7.51 million in December), but we take little reassurance from that since the reference period was before all the drastic government-sector personnel changes instigated by DOGE. Whether or not some of the announced layoffs are walked back (at least temporarily) following court orders, the idea that the federal government is on a de-facto hiring freeze remains. Even if some of the federal funding cuts are also reinstated (at least temporarily) also due to court orders, the fact remains that funding flows will diminish on a go-forward basis and uncertainty around them has sustainably increased. Hence, there will likely be a fairly quick response from the private sector with hiring freezes of their own, especially in areas like education and life sciences. Meanwhile, tariff uncertainty could also put hiring plans on hold among small businesses, whichis where job openings are still robust.

For a hint on the bumpy road ahead, look no further than the collapse in the University of Michigan consumer sentiment survey. Having risen to an eight month high in December, sentiment has since collapsed, with outsized declines in both February and the preliminary March reading as tariff threats (and DOGE disruptions) intensified. The index lost 6.8 points in March and a cumulative 16.1 since December. At 57.9, it is now at the lowest level since November 2022 (Figure 1, page 3). At the same time, inflation expectations continue to surge, with 1-year inflation expectations up another 0.6 percentage points (ppts) to 4.9% and 5-10 year inflation expectation up 0.4 ppts to a record 3.9%. What is astonishing is the speed with which consumers are responding to tariff concerns this time around. Short term inflation expectations have nearly doubled since November: from 2.6% to 4.9%. There is only one word to describe this: extraordinary! This is certainly one of the factors that could sway the Fed against cutting interest rates, but the one counterpart so far is that business inflation expectations have been much more stable, suggesting that despite tariff threats, pass-through may be much more limited than consumers fear.. Still, this is a critical indicator to watch.

Canada: Further Rate Cuts Are On The Way

The Bank of Canada (BoC) delivered another 25 bp cut, bringing the policy rate to 2.75% as widely expected. Just a few weeks ago, the odds of a March rate cut were quite low. If not for the trade war with US (which officially kicked off last week), the BoC would have probably paused at this meeting given the better-than-expected Q4 GDP print and the fact that the policy rate has already been lowered by 200 bps since June.

Employment and inflation data were solid recently, reflecting the impact of monetary easing. But concerns about recessions have risen sharply since the Trump administration imposed steep tariffs on imports from Canada on 4th March. In his press conference, Governor Macklem stated that “the economic impact could be severe. The uncertainty alone is already causing harm." After all, over 75% of Canadian exports go to the US, which is equivalent to 20% of Canadian GDP.

As in January, the bank also noted two-sided risks to inflation, with “downward pressures on inflation from a weaker economy and the upward pressures on inflation from higher costs”. The statement sounds more hawkish when it mentioned “Monetary policy cannot offset the impacts of a trade war. What it can and must do is ensure that higher prices do not lead to ongoing inflation”. However, the elevated uncertainty around trade policy when unemployment rate is 6.6% and inflation is at target will likely trigger a more dovish response from the BoC in coming months.

Overall, we expect that the uncertainty around trade policy will remain elevated through this year and beyond. We remain our view that the policy rate will reach 2.25%, its low end of neutral rate range, by June.

Japan: Wage Momentum Remains Intact

Members of Japan’s largest labor union demanded an average raise of 6.09% for the next fiscal and received 5.46% in the first round negotiation. The outcome is a 3- decade high and could be revised a few notches lower in subsequent rounds. Although a handful of firms fully met the demands of their labor unions this year, (for example, electronics major Hitachi fully met the demand of 6.2%), a majority of them agreed to a slightly smaller hike than demanded.

We expect this year’s raise to eventually come strikingly close to last year’s average of 5.1%, with a good chance of besting it. This would help Japan transition into a phase where inflation will be led by wages and growth by domestic demand. Wage dynamics are shifting to better reflect labor shortages, but are driven by inflation, a critical issue in Japan today.

The divergence in CPI inflation relative to its pre-pandemic mean is striking in Japan compared with other nations. Although the Bank of Japan (BoJ) dialed up their hawkishness, they are still not in a clear “inflation fighting” mode, as ‘underlying inflation’ has not hit their 2% target yet. The consequence could be elevated high headline inflation for longer. Next week, CPI data for February would be in focus and we expect the BoJ-core metric (excluding fresh food and energy) to rise 2.5% y/y. Rice prices will be in focus after they rose 95% due to acute shortages.

Q4 GDP growth rate was revised down marginally to 2.2% q/q saar (from 2.8%), predominantly due to a large downside revision to inventories, but consumption was also revised lower to 0.1% from the preliminary 0.5% gain. Nonetheless, this marked the third strong quarterly growth rate and is an important reason behind our key forecast of domestic demand led growth in 2025, a positive economic transition.

Still, the BoJ is unlikely to hike next week, or even move into a rapidly hiking mode given its nimble approach to policymaking. This is a fair approach given the heightened uncertainty gripping the global economy currently. We also think it is a good idea for the Bank to hold until clarity emerges on President Trump’s reciprocal tariffs, perhaps in early April.

The fine print and Governor Ueda’s press-conference will be in focus, and we think the BoJ could turn more hawkish and begin setting the stage for a subsequent hike. We see two more hikes this year, with the next hike likely coming in June. Either way, we prefer the BoJ raising rates sooner rather than later.

Spotlight on Next Week

1. The Fed to hold rates, highlight uncertainty and inflation risks.
   
2. The BoE to remain on hold.
   
3. The BoJ to hold but turn more hawkish.