Inflation cools

April’s inflation data provided a mixed yet cautiously optimistic outlook. The Consumer Price Index (CPI) rose 0.2% month-over-month, bringing the annual rate down to 2.3%—the lowest since February 2021. Core CPI, which excludes food and energy, increased by 0.2% in April and 2.8% over the past year, aligning with expectations. Notably, food prices declined by 0.1% in April, driven by a significant 12.7% drop in egg prices. Conversely, the Producer Price Index (PPI) fell 0.5% in April, marking its largest monthly decline since 2009, primarily due to a 0.7% decrease in service costs. Year-over-year, the PPI rose 2.4%, down from 3.4% in March. These figures suggest that while inflation is cooling, the Federal Reserve remains cautious, especially with potential inflationary pressures from recent tariffs yet to materialize.

• While the month-over-month inflation numbers were encouraging, the 12-month change is still stubbornly above the Fed’s two percent target
• That said, this could give the Fed cover to lower rates sooner than the market is currently pricing in
• We believe that there will be continued volatility in the economic data in the months to come as the effects of the original tariff announcement are seen in the data
• As a reminder, consumer prices are still 25% higher than they were pre-COVID

Consumer sentiment 2nd lowest in history

U.S. consumer sentiment declined for the fifth consecutive month in May, with the University of Michigan's index falling to 50.8—its second-lowest level on record. This drop reflects growing concerns over President Trump's trade policies and their potential to drive up inflation. Year-ahead inflation expectations surged to 7.3%, the highest since 1981, while long-term expectations rose to 4.6%. Despite a recent 90-day pause in tariffs between the U.S. and China, the survey indicates that consumers remain apprehensive about the economic outlook.

• It is important to note that this data is survey data
• Before 2025, the survey was done via phone calls with roughly 500 households
• Since the beginning of this year, the survey shifted to an online model
• Either way, the way consumers answer a survey versus how they behave is not always consistent
• For instance, data released from both Mastercard and Visa this week showed that the consumer remains resilient
• That said, on a relative basis, the reading was likely reflecting uncertainty following the original tariff announcements in April
• The more concerning part is the inflation expectations, which can be prone to a self-fulfilling dynamic
• If consumers expect prices to be higher later, they may accelerate purchases, which in and of itself can influence prices

Japan’s economy contracts, yields surge

Japan's economy contracted by 0.2% in the first quarter of 2025, marking its first decline in a year and exceeding expectations of a 0.1% drop. This downturn was driven by a 2.3% fall in exports amid escalating U.S. tariffs, while domestic consumption remained flat. Capital expenditure rose by 1.4%, but this uptick wasn't sufficient to offset the broader economic weakness.  In the bond market, yields on Japanese government bonds have surged, with the 30-year yield reaching nearly 3%, the highest in almost 25 years. This rise is attributed to concerns over Japan's fiscal health and decreased demand from life insurers. The Bank of Japan faces challenges in adjusting its quantitative tightening strategy, aiming to halve monthly bond purchases to 3 trillion yen by March 2026. Despite these challenges, foreign investors poured a record ¥8.2 trillion ($57 billion) into Japanese equities and bonds in April, seeking a safe haven amid global market volatility and concerns over U.S. trade policies. The Bank of Japan remains cautious, maintaining its key interest rate at 0.5% and signaling a potential delay in further rate hikes due to the fragile economic recovery and global uncertainties.

• We pay attention to Japan, because they were the first developed country in the world to pursue a zero interest rate policy following a financial crisis
• This began post their asset bubble bursting in the early 90s
• Since then, they have run fiscal deficits every year for 30 years, and their debt-to-GDP has exploded to 260%
• Given low interest rates and the fact that the Bank of Japan (Japan’s Central Bank) holds 50% of the outstanding debt, this has thus far been manageable
• Now that interest rates are rising, due to inflation, this will become a more acute problem
• While not completely comparable, Japan serves as a bit of a roadmap for the path of the United States

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