US markets at all-time high on 'good' inflation data: Can the rally continue?

V K Vijayakumar from Geojit Financial Services believes that the RBI will only consider cutting rates after the Union Budget presentation in July. A little patience can go a long way, after all.

The S&P 500 reached an all-time high of 5,325 on May 16, riding a wave of investor euphoria over surprisingly good inflation numbers on Wednesday. Inflation has been the main culprit behind stock market turbulence worldwide over the past couple of years.

Soaring economic growth, a sizzling labour market, and rising commodity prices — fueled by geopolitical conflicts and supply-chain issues — forced central banks, led by the US Federal Reserve, to crank up rates to tame the inflation beast.

But now, with inflation finally showing signs of mellowing out, are we on the cusp of a fresh stock market rally?

Inflation receding? Yes, please!

US CPI inflation rose less than expected in April, signalling a welcome return to a downward trend. The US consumer price index (CPI) rose 0.3 per cent sequentially. In the 12 months through April, the CPI increased 3.4 percent YoY, which follows a 3.5 percent rise in March.

The annual increase in consumer prices has dropped from a peak of 9.1 percent in June 2022; however, progress has since slowed.

The April CPI data marks the first month of slowing annual data since January 2024. The year-over-year CPI increase was the slowest in three years, giving policymakers hope that further declines are on the horizon.

Additionally, data showed that retail sales were unexpectedly flat in April, suggesting that domestic demand was cooling, which will be welcomed by officials at the U.S. central bank as they try to engineer a "soft landing" for the economy.

Analysts are buzzing about the possibility of rate reductions. Anticipation of a rate cut in September sent bond yields tumbling and pushed US markets to record highs. It's like Christmas came early for investors.

Krishna Guha, Vice Chairman at Evercore, was quoted in Bloomberg saying that the April inflation report could lead to a rate cut in September, followed by another in December.

Gary Pzegeo of CIBC Private Wealth US chimed in, noting that decelerating retail sales support a Fed rate cut in the fall. While some skeptics still believe rates will stay higher for longer, the surge in stock prices seems to scoff at such predictions.

That positivity in stock markets may be in part arising from the narrative coming from central bankers around the world.

Will BoE, ECB cut rates before the Fed?

Globally, other central banks are already preparing their rate-cutting scissors. The Bank of England (BoE) hinted it might soon trim rates, with Governor Andrew Bailey indicating that markets might be underestimating the pace of easing.

The BoE's recent decision to keep the base interest rate at 5.25 percent was coupled with encouraging inflation data, making it look like the BoE is ready to join the rate-cut party. Inflation in England has declined from 10.1 percent in March 2023 to 3.2 percent in March 2024.

Similarly, the European Central Bank (ECB) observed ongoing declines in inflation, driven by lower food and goods prices. Although wage growth is moderating, the ECB is taking a cautious, data-dependent approach.

President Christine Lagarde emphasised that the ECB's decisions are independent of the Fed, sparking speculation that the ECB might cut rates first. Seems like the ECB wants to steal the spotlight on the rate-cut dance floor, but does it have what it takes?

Europe’s economic context is a bit of a mixed bag compared to the US. The Eurozone's sluggish growth has led to a disinflationary process aligned with the ECB's expectations. The eurozone economy is growing half as fast as the UK as Britain bounced back stronger from recession.

According to figures from Eurostat, GDP across the eurozone grew by 0.3% in the first quarter of 2024, meaning that while its recession is over, growth is still half the 0.6 percent recorded in the UK during the same period.

In contrast, the US economy shows signs of healthy cooling, potentially easing remaining inflation pressures. French economist Mathilde Lemoine cautions that an early ECB rate cut could risk growth and inflation by depreciating the euro, increasing imported inflation, and dampening private sector optimism.

Premature action might also ding the ECB's credibility if misjudged—no one wants to be the early bird who didn’t get the worm.

RBI's Path: Decoupling from the US Fed?

In India, retail inflation slightly eased to 4.83 percent in April, comfortably within the Reserve Bank of India's (RBI) target range of 2-6 percent, though marginally above the ideal 4 percent. Despite global inflation worries, India has managed its inflation trajectory with finesse.

Rajani Sinha, Chief Economist at CareEdge Ratings, suggests that a normal monsoon could improve the outlook for food inflation, potentially leading to an RBI rate cut in the second half of FY25 if conditions remain stable.

India's inclusion in the JP Morgan Bond Index, expected to bring $20-25 billion of foreign flows, offers additional comfort for the RBI. Thus, there's no urgent need for the RBI to cut rates prematurely, given the strong economic growth.

Ajit Mishra from Religare Broking expects the RBI to monitor the monsoon and geopolitical tensions before changing its policy stance. V K Vijayakumar from Geojit Financial Services believes that the RBI will only consider cutting rates after the Union Budget presentation in July. A little patience can go a long way, after all.

What about ‘other’ countries?

While some countries like Sweden, Brazil, and Peru have already cut rates, many—from Australia and Malaysia to Poland, and Serbia—are still waiting for the US to take the lead.

However, the stance of most central banks and the declining trend in inflation across countries, including the US, suggest that the global inflation problem may finally be easing. Hallelujah!

Is it time to buckle up for a jolly good ride in the stock markets again? Well, each country will have a story of its own, and in any case, that has to be a story for another day.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.