US April CPI Report Falls Short of Expectations

Federal Reserve Maintains Caution Despite Inflation Decline

by Faruk Imamovic
US April CPI Report Falls Short of Expectations
© Getty Images/Spencer Platt

The release of the US April Consumer Price Index (CPI) report on Wednesday brought with it a wave of speculation and anticipation among traders. However, the excitement quickly dissipated as the report's substance did not match the hype. The data indicated a decline in inflation, but not to the extent that would prompt immediate action from the Federal Reserve. This cautious approach was further reinforced by statements from key Federal Reserve officials, including Cleveland's Loretta Mester, New York's John Williams, and Richmond's Tom Barkin, who emphasized the need for more consistent and significant downside in inflation prints before considering a rate cut.

The prevailing sentiment among these officials is that the convergence to the 2% inflation target will require a sustained period of lower inflation rates. This means that while a rate cut in the third quarter (Q3) of this year remains unlikely, it could become a possibility in the fourth quarter (Q4), contingent on further economic data. However, even if a Q4 rate cut occurs, it would not be followed by aggressive rate cuts unless a demand-side driven recession emerges.

Chile's CLP: Riding the Copper Rally

Turning our attention to Chile, the Chilean Peso (CLP) has shown remarkable resilience and outperformance, buoyed by a significant rally in copper prices. Copper, a critical export for Chile, has seen its prices surge, improving the country's terms of trade. This positive momentum for the CLP is expected to continue, even if the copper rally experiences a partial reversal. The rationale behind this optimism lies in the fact that the improvement in Chile's terms of trade is not yet fully reflected in the USD/CLP exchange rate, and local economic growth fundamentals are showing signs of improvement.

Chile's central bank, Banco Central de Chile (BCCh), had previously implemented a series of aggressive rate cuts, slashing rates from 11.50% to 6.50% over several months, with two of these cuts being a substantial 100 basis points each. This dovish stance was justified by a sharp decline in inflation, which fell from a peak of 14% to around 4.5% in the first quarter (Q1) of 2024. The aggressive rate cuts contributed to the underperformance of the CLP in early 2024. However, as inflation began to stabilize and economic growth prospects improved, the BCCh adopted a more hawkish tone, signaling a shift away from further rate cuts.

Chilean Peso Strengthens Amid Copper Price Surge
Chilean Peso Strengthens Amid Copper Price Surge© Getty Images/Marcelo Hernandez

Global Economic Context and Its Impact on Markets

European stock indexes and US index futures have had a muted response recently, reflecting a lack of enthusiasm following a disappointing session overnight. Much of the market's attention had been on anticipated data and policy measures from China, which failed to deliver the expected boost. The People's Bank of China (PBoC) announced a CNY 300 billion program of subsidized funding at 1.75% to help state-owned companies, including commercial lenders and joint-stock banks, purchase unsold homes from property developers. These homes would then be resold to local governments as affordable housing, particularly in cities with a large inventory overhang. Additionally, the PBoC eliminated the nationwide policy floor for interest rates on commercial mortgage loans for first-time and second-time home buyers.

Despite these measures, the reported April data in China was weak, with retail sales, fixed asset investment, and residential property sales all coming in lower than expected. Housing prices also fell more than anticipated, underscoring the urgency of the announced measures. This weak data from China contributed to the lackluster market sentiment, which was compounded by the realization that the US inflation decline was less significant than initially thought.

The Prospects for the CLP

As we look ahead, the outlook for the CLP remains positive, driven by several factors. First, the recent rally in copper prices has some fundamental support, particularly from the tightening of supply as mines have shut down. Our commodities team projects a small deficit this year due to supply growth lagging behind demand. While supply-side disruptions alone do not fully explain the synchronized increase in base metal prices, the broader market conditions suggest that the current copper price levels may persist.

Furthermore, the strength of the USD, the slow demand growth backdrop in China, newly announced tariffs on electric vehicles (EVs) from China to the US, and the ongoing weakness in Germany's industrial sector present a mixed global economic picture. Despite these challenges, if the bulk of the increase in copper prices holds, it will significantly improve Chile's terms of trade and its ability to address its trade and current account imbalances.

The combination of improving local growth fundamentals, a more balanced monetary policy stance from the BCCh, and favorable terms of trade suggests that the CLP has room to appreciate further. Our projection for the USD/CLP exchange rate remains at 880 by the end of 2024, with the potential to adjust this target to 850 if the copper rally remains robust.

Federal Reserve