The Fed Stays Put

Here are some of the biggest stories from last week:

• The World Bank lifted its global growth forecast for this year.
• US inflation cooled by more than expected in May.
• The Fed kept interest rates unchanged and signaled just one cut in 2024.
• UK wage growth held steady in the three months to April.
• Britain’s economic recovery ground to a halt in April.
• Catastrophe bond issuance reached a record high in the past five months.

Dig deeper into these stories in this week’s review.

Global

The World Bank raised its global growth forecast for this year – driven by strong economic expansion in the US – while warning that climate change, ongoing conflicts, and high debt levels will hurt poorer countries, where most of the world’s population lives. The institution lifted its 2024 global growth forecast to 2.6% from an earlier prediction of 2.4%, but kept its 2025 estimate unchanged at 2.7%. Most of the improvement stems from the World Bank upgrading the US growth outlook to 2.5% from a previous estimate of 1.6%. Finally, global inflation is projected to moderate at a slower clip than previously assumed, averaging 3.5% this year and 2.9% in 2025. That means that many central banks are likely to remain cautious about cutting interest rates this year, according to the World Bank.

US

All eyes were on this week’s latest US consumer prices report, which showed inflation was cooler than anticipated in May. The annual pace of inflation ticked down slightly last month to 3.3% from 3.4% the one before, defying economist expectations for an unchanged reading. Core inflation, which strips out volatile food and energy items to give a better idea of underlying price pressures, fell by slightly more than forecast to 3.4% – its lowest level in just over three years. On a month-over-month basis, consumer prices remained flat, while core prices increased by 0.2%. Both marked a bigger-than-expected deceleration from their paces in April.

Overall, while the report offers the Fed some hope that inflation is resuming its downward trend, officials will probably want to see further evidence of it falling to gain the confidence they need to start cutting interest rates.

Speaking of the Fed, the US central bank kept its benchmark interest rate unchanged at a two-decade high for a seventh straight meeting this week. But policymakers signaled that they now expect to cut rates just once this year, compared to the three reductions forecast in March. They now see four cuts in 2025, more than the three previously outlined. Finally, in updated projections, the Fed expects the personal consumption expenditures index – the central bank’s preferred inflation gauge – to increase by 2.6% this year, up from a previous estimate of 2.4%. It left its forecast for economic growth and unemployment unchanged, at 2.1% and 4% respectively.

UK

Across the pond, new data this week showed UK wage growth held steady in the three months to April, defying predictions for a slight acceleration. Average annual growth in regular earnings, excluding bonuses, came in at 6%, unchanged from the three months to March. Growth in total earnings including bonuses, meanwhile, also remained steady at 5.9% – softer than the 6.1% forecasted by economists, despite an increase in the minimum wage that took effect in April. Other indicators also pointed toward a cooling labor market, with the UK unemployment rate unexpectedly rising to 4.4% – its highest level in more than two and a half years. While this may be unwelcome news for Brits, it likely suits the Bank of England, which sees a slowing labor market as crucial to reducing the country’s high inflation.

But it wasn’t all doom and gloom for Brits: the labor market figures showed that living standards continued to improve this year, with real wages growing 2.9% in the three months to April compared to the same period last year. That was the highest growth rate in real wages since the summer of 2021, and marked the tenth consecutive month of pay increases outpacing inflation.

That said, although households are enjoying higher real wages, they were hesitant to spend during the unusually rainy April, which was one of the wettest months on record. In fact, April’s rainfall hit the retail and construction sectors so badly that the UK economy completely flatlined that month, according to new data this week. In other words, the British economy saw no growth in April, marking a big slowdown from the 0.4% expansion seen in March and indicating that the rebound from last year’s recession appears to be losing momentum. Economists expect a meager 0.6% expansion for the whole of 2024, up from just 0.1% last year but well below the trend levels the UK enjoyed in previous decades.

Bonds

Catastrophe bonds (or “cat bonds”) are debt instruments that allow insurance companies to protect themselves in the event of major disasters – like hurricanes or earthquakes – by transferring some or all of the risk to investors. By buying these unique instruments, cat bond investors are essentially betting that a major natural disaster won’t happen. If it does, they stand to lose some or all of their money, which would be used to cover the cost of damages inflicted by the disaster. If it doesn’t, they earn an interest rate that’s typically higher than most other types of bonds.

The market for these instruments has been particularly active this year, with weather forecasters expecting a particularly rough hurricane season with the potential to do substantial damage. That’s driving insurers to seek additional protection through cat bonds, with issuance surging 38% in the first five months of 2024 compared to the same period last year to hit a record $11.7 billion. What’s more, the $4 billion issued in May alone represents the greatest volume of cat bonds ever sold in a single month.

Investors have been more than happy to snap up all the new supply, and it’s not hard to understand why: cat bonds did spectacularly last year, with the Swiss Re Global Cat Bond Index gaining 19.7%. That’s well above the 5.7% return from the Bloomberg Global Aggregate Index, which is made up of investment-grade government and corporate bonds. What’s more, on top of their strong potential for returns, cat bonds offer diversification benefits since their performance generally isn’t correlated with traditional asset classes like stocks or regular bonds. They’re driven, after all, by hurricanes, earthquakes, and the like, not by market rallies and crashes.

Still, investors shouldn’t become too complacent considering that they could lose some or all of the money they invested in a cat bond if the specified catastrophic event occurs. And that risk is not something to sneeze at these days, with climate change leading to more frequent natural disasters, and increased property exposure and inflation leading to higher insurance losses.

Next week

• Monday: China industrial production and retail sales (May).
• Tuesday: US retail sales (May), US industrial production (May).
• Wednesday: Japan trade balance (May), UK inflation (May).
• Thursday: China one-year loan prime rate announcement, Bank of England interest rate announcement, eurozone consumer confidence (June). Earnings: Accenture.
• Friday: Japan inflation (May), UK retail sales (May), US, UK, Japan, and eurozone PMIs (June).