Optimism spreads as overseas markets surge again before the release of key inflation data

Betting on the "cooling down" of US inflation, the market once again takes an early lead.

This week, the highly anticipated US CPI inflation data will be released on Wednesday. Market expectations are generally that the core CPI in April is expected to rise by 0.3% month-on-month, marking the first slowdown in six months; the year-on-year growth rate is expected to reach 3.6%, the smallest increase in three years.

After three consecutive months of overheating in US inflation data, Wall Street's expectations for a Fed rate cut have been severely impacted. Now the market is betting on a cooling down of CPI, with US stocks and bonds rebounding in renewed optimism about an economic "soft landing". In pre-market trading on Monday, futures for the three major US stock indexes all rose.

Inflation remaining high has been the main concern for investors recently. As we enter 2024, traders originally bet that the Fed would implement up to six rate cuts, but the persistent overheating of inflation has forced them to sharply reduce their rate cut expectations. As a result, US stocks suffered a heavy blow in April, with bond yields soaring to their highest level since November.

Many investors believe that the April non-farm payroll report has alleviated some concerns, as a cooling labor market will eventually lead to a slowdown in inflation. Now, only actual inflation data is needed to confirm this. Gennadiy Goldberg, head of US rate strategy at TD Securities, stated:

The CPI report may further support expectations for rate cuts this year.

Clear Signs of Cooling Down in CPI

Most economists remain optimistic, believing that inflation will show a downward trend again. They point out that goods inflation has dropped to near the Fed's target level. Officially measured housing inflation remains high, but it is expected to eventually fall to a level more consistent with the increase in private sector rents.

Chief economist at Morgan Stanley, Seth Carpenter, previously stated:

The US CPI will be "significantly lower than expected", current rental data is very weak, despite a surge in immigration last year, vacancy rates in multi-family apartments are approaching historical highs, signaling a downturn in housing inflation.

In addition, changes in service sector inflation tend to be slower, with the decline lagging behind goods inflation. Many economists expect that as new and used car prices fall, car insurance and maintenance costs will also decrease in the coming months. The latest non-farm payroll report shows a cooling labor market, releasing positive signals, as labor costs are a major driver of changes in service prices.

Greater Upside Potential for US Bonds than US Stocks

With optimistic expectations, investors are flocking to soft landing trades. Since the beginning of this month, the Dow has accumulated a 4.5% increase, approaching the historical high set in late March. US bonds have also risen, with the 10-year Treasury yield dropping from 4.7% in late April to the current 4.503%.

Analysis indicates that if inflation slows down, most investors believe that the upside potential for bonds will be greater than that of the stock market, as it is nearing record highs, but the 10-year yield is still far above the 4% level at the beginning of the year. Over the past two years, the performance of US bonds has been disappointing, with interest rates continuously rising beyond investors' expectations, and for a longer duration than expected. Nevertheless, at the first sign of inflation easing, investors rush to buy bonds, eager to lock in a yield of 4%-5% before the Fed cuts rates.

Ed Perks, Chief Investment Officer of Franklin Templeton Fixed Income Investments, stated:

If data shows that inflation is slowing down, short-term US bond yields may decrease by 0.2%-0.25%, while long-term US bond yields may decrease by 0.1%-0.2%.

Given the current stock valuations, seeing a significant rise in the stock market would pose a greater challenge. Similarly, if inflation data exceeds expectations again, there may be more downside potential for US stocks