What we would note is that the “problem” here (where “problem” is rising yields) hasn’t gone away. 10Y yields are pushing up against 2.90, not far away from what a lot of folks think is the point of no return beyond which the bottom falls out for equities.
And of course this all gets back to the root issue, which is irresponsible fiscal policy accelerating the time table on Fed hikes and very likely pulling forward the end of the cycle as Albert Edwards details in his latest missive.
When looked at in the context of the fiscal backdrop and the prospect of decreased demand for U.S. debt at a time of increased supply and Fed balance sheet rundown, the jitters look a lot more rational than they might if all you knew was that the entire market was laser-focused one month’s CPI reading.
In any event, Wall Street’s takes are trickling in and in light of how critical this number is to the narrative, it’s worth running through some of the color.
Core inflation surged higher in January to 0.3495% MoM, the highest monthly reading since March 2005. This is the third consecutive year where core CPI has outperformed in January, and at least some of the strength appears to be driven by unusual seasonality. YoY core inflation was unchanged at 1.8%, although consensus was expecting a decline. Along with strong wage data in the January employment report, today’s numbers are likely to raise concern among markets and policymakers that inflation may finally be rising in earnest after years of downside surprises.
The extreme upside surprise in today’s report was driven by unusual seasonal patterns, but there is some legitimate strength in the core inflation trend as well. We now expect YoY core CPI to reach 2.3% by yearend, and YoY core-PCE to rise to 1.9%. Along with better wage growth, multiple rounds of fiscal stimulus, and a weaker dollar, inflation risks are clearly shifting to the upside.
The big picture takeaway, in our opinion, is that these reports allow the Fed to move forward on its path of gradual Fed Fund increases and likely puts the Fed risk to the upside. On equities, the market is taking some off the top but these reports, in our view, were not extraordinary. Ultimately, we believe equities gain ground over the coming days and weeks as investors acclimate to a higher interest rate environment, focus on fundamentals, find more value in the stock market (SPX = 17X) and we progress through the derisking process (liquidity providers return). In the near-term (across sectors), we believe the numbers help keep a relative bid to Financials and weighs on bond proxies.
The January core CPI price index increased by more than expected, with the nearly four-tenths pace the fastest in twelve years. The year-over-year rate remained stable at 1.8%. Over half of the Core CPI acceleration originated in volatile categories such as apparel and household furnishings, but we would not expect a reversal in these price indices next month. As important, the more persistent shelter and medical care categories were also firm. As a result, we now expect Core PCE inflation to end the year at 1.9% (vs. 1.8% previously). Headline and core retail sales were weaker than expected in January, and the levels in prior months were revised down significantly. While the retail sales report suggested downside risk to our past-quarter tracking estimates for Q4, we note that tax cuts were not fully implemented in January, and accordingly, we expect retail spending to firm later in the quarter. We left our Fed probabilities unchanged, with subjective odds of a March hike at 95%.
Core CPI inflation accelerated to 0.3% in January, and almost rounded up to 0.4% as it came in at 0.349% unrounded. This beat expectations of 0.2%. That said, it is important to remember that there is a residual seasonality bias in January, so it is likely that the core inflation data settle back down to 0.2% over the course of the year. Consistent with this seasonal bias, the % yoy rate held at 1.8% (1.845% unrounded). The surprise CPI was driven by a 1.7% surge in apparel, a common source of seasonality, which provided a 7bp bump in Jan’s % mom reading relative to Dec. Transportation and medical services were other important drivers, the former accelerated to 0.8% mom from 0.3%, and the latter up to 0.6% from 0.2%. Both added 4bp to the monthly core reading, relative to December. Conversely, core transportation commodities slowed to 0.1% from 0.6% as new cars decreased 0.1% and used cars slowed to 0.4% from 0.7%. Lodging away from home slid 2.0% mom. Meanwhile, OER inflation held in at 0.3%.