Softer US Inflation - Selling The Fact
Markets were expecting US inflation to continue marching lower, and that’s exactly what happened. However, there was plenty of optimism already baked into the cake after some strong moves to start the year.
The December US CPI printed bang in line with expectations
- Headline CPI was -0.1% Month on Month and +6.5% Year on Year
- Core CPI was 0.3% Month on Month and + 5.7% Year on Year
The S&P 500 reacted negatively on the cash open, but looks to be turning higher as the session progresses. Up by over 2.5% since the start of the year, the stock index rallied right into the 200 day moving average, and declining trend line and returned to the start of the move lower from mid-December
Soft landing hopes are alive and well though, so any pullback could be brief. Inflation continues to slow, and the past three core inflation (excluding volatile food and energy) readings are much more in line with 2% annual inflation as this ING graphic shows:
The deceleration continues after headline had peaked at 9.1% year-on-year in June and core at 6.6% YoY in September. We still aren’t below the 0.17% month-on-month threshold that over time would get us to the Fed’s 2% YoY target, but the last three months of data are a notable step down from the 0.5-0.6% MoM average seen through the second and third quarters of 2022, giving the Fed justification to raise rates by 25bp from now on.
Indeed, the first Fed speaker to hit the wires after the release was Philadelphia Fed president Patrick Harker, a 2023 voter. He stopped short of declaring victory, but was highly encouraged by the drop in inflation so far:
Also in the rearview mirror, I expect, are the eye-popping inflation readings of 2022. With monetary policy doing its work, supply chains healing, and excess demand running off, I forecast core inflation to come in at around 3.5 percent this year — well over our 2 percent target, but suggestive of clear movement in the right direction. Core inflation should fall to 2.5 percent in 2024 and then back down to 2 percent in 2025.
Harker laid out his thoughts over further rate hikes in 2023 too:
Last year, we raised the target for the federal funds rate to between 4.25 percent and 4.5 percent. That was a significant move, and a very fast one, given that we started the year at about 0 percent. I expect that we will raise rates a few more times this year, though, to my mind, the days of us raising them 75 basis points at a time have surely passed. In my view, hikes of 25 basis points will be appropriate going forward.
At some point this year, I expect that the policy rate will be restrictive enough that we will hold rates in place to let monetary policy do its work. We are also shrinking our balance sheet, which is removing a significant amount of accommodation in and of itself.
Our goal is to slow the economy modestly and to bring demand more in line with supply.
Presuming the Fed hikes by 25bps (0.25%) at each of the next two or three meetings, that would leave the Fed Funds rate at, or around 5%.
The market focus might quickly shift from inflation concerns to growth worries and if those above-target inflation projections are valid or if rate cuts to support the economy will be needed sooner than envisaged by Fed officials.
For now, the soft landing narrative looks to be in command, but the S&P 500 is at a crucial juncture here. “Nothing good happens below the 200 day moving average” so recovering that area and pushing on could trigger some chasing from momentum traders and further upside for the index.
Not investment advice. Past performance does not guarantee or predict future performance.
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