by Hubert Marleau, Market Economist, Palos Management
February 17, 2024
The Bureau of Labor Statistics reported a 3.1% headline CPI year-over-year increase in January, which was was down from 3.4% in December, but higher than the 2.9% the Cleveland Fedās inflation NowCasting model has been predicting. This inflation reading was a nasty surprise, which pushed back market expectations of imminent interest rate cuts, while the swap market raised its prediction that inflation would be 3.3% in one yearās time, having been 2.0% at the beginning of the year.
This was totally caused by a blistering 0.9% m/m increase in āsupercoreā inflation, as a result of which the readjustment in bond yields not only pushed out the collective forecast for interest rate cuts in 2024, but brought back rate-hike murmurs on the trading floors and discussions in the press. The bond marketās worst fears about inflation pretty much came to pass on Tuesday.
While the body-check from stubborn pricing pressure should not be ignored, there are nonetheless plenty of reasons to anticipate a re-establishment of the disinflation narrative. A single report does not kick the economy off the disinflationary path. Indeed, the January print looks more like a blip than the start of a new inflationary wave. The bottom line is that the monetary risk is skewed toward a prolonged pause as the last disinflationary mile might be choppy.
Digging deeper, however, there are signs that the January numbers were funky - more noise than signal - accounting for all of the miss. Firstly, many businesses involved in medical services, personal care and daycare made start-of-the-year price adjustments, passing on the unusually large input costs which took place last year. Secondly, the 0.6% m/m increase in the rent of primary residences looks suspicious. Rents reset infrequently because of the slow way the BLS reports shelter costs. Indeed, the dramatic cooling in housing statistics that have occurred since 2022 has not been officially reflected so far. High frequency data produced by Zillow has shown
U.S. rents down on a y/y basis for 8 consecutive months. Eventually, rental inflation will converge on newly signed leases.
Overall, we hardly have a backdrop that should make investors hit the panic bottom. Excluding shelter and seasonal January price effects of businesses, where the numbers are funky, the headline and core CPI were up just 1.6% and 2.2% y/y through January, with a 3-month annualised rate of 1.1%. As a matter of fact, inflation expectations, which are the most important input to realised inflation, are not only well anchored but falling. According to a consumer survey conducted by the NY Fed, 3-year-ahead expectations are 2.4%. Austan Goolsbee, the Chicago Fed President, told the Council of Foreign Relations that inflation doesnāt necessarily need to be as low as it was during the last 6 months of 2023 for the Fed to have confidence that it is returning to its 2% goal. Meanwhile a pair of economic prints on retail sales and industrial production were both weaker than expected as they contracted in January, which gave releases relief to the markets as Fed swaps fully priced an interest rate cut in June.
The Market Outlook
Nonetheless, Wall Street was caught off-guard by the hotter-than-expected U.S. consumer and producer inflation readings, giving speculators reasons to take some trading profits in the form of a tactical correction. The CBOE Skew Index, a measure of the perceived tail risk, shot up to 171 from 150.
Fortunately, this index is far better at revealing what the traders are doing now than predicting negative outcomes. In fact, this is a healthy development for the sustainability of the bull run; and my hunch is that the broad market might fall, short term, to test 4850, where it's likely to find support. In this connection, bottom-pickers should consider buying dips in stocks that they like. Why? I maintain the view that the S&P 500 will nudge toward 5400 in 2024 and further along to 5900 in 2025. Take note that all-time highs are usually followed by more all-time highs and that it doesnāt take much to positively change the mood in the stock market like we witnessed in the last few days.
Despite all the the unsettling January increases in inflation, the y/y trend in both consumer and producer price indices remaining downward, along with the sharp fall in retail sales and construction of new homes, the Atlanta Fedās NowCasting model is still predicting a 2.9% annual rate of increase in the GDP for Q1. This perhaps explain why the the S&P 500 hovered around the 5000 mark all week, except on Tuesday.
P.S. 1 According to SocGenās Manish Kabra, if one were to apply the math prevailing at the peak of the ā dot.comā bubble - that irrational exuberance of the late 1990s - it could even drive the S&P 500 to 6250.
P.S. 2 Iām on a cruise ship until March 22. There will be fewer letters (unedited plus short and sweet.)
Copyright Ā© Palos Management
