Define Irony: Market Reaction To CPI Undermines Inflation Fight

The knee-jerk reaction across assets to a cooler-than-anticipated read on inflation in the US was directly contrary to the Fed’s inflation-fighting agenda.

I assume that’s obvious to most readers, but it’s worth reiterating, especially to the extent it mirrored the price action observed during and after Jerome Powell’s press conference following the July FOMC meeting.

All year, policymakers have worked to engineer tighter financial conditions. Higher yields (particularly real yields), a stronger dollar, falling stocks and modestly wider credit spreads, are all consistent with the Fed’s efforts to combat the hottest price growth in four decades.

Last week was defined by a hawkish cacophony from a bevy of Fed speakers, all of whom sought, in many cases explicitly, to dispense with the notion that anything in Powell’s remarks should be construed as indicative of an inclination to dial back tighter policy at the first opportunity. Mary Daly and Need Kashkari were very adamant in that regard.

In the wake of July’s CPI report, US equities surged, the dollar fell, commodities rallied and yields retreated, moves which, if sustained, could undermine the inflation fight, prompting yet another all-hands-on-deck effort to dissuade markets from getting ahead of themselves based on a single monthly inflation print.

The figure (above) compares the initial reaction to July’s CPI report to price action around the July FOMC meeting and Powell’s press conference.

Note that although the long-end unwound an initial bid following the inflation data (i.e., yields moved back to unchanged), that was likely due in part to concession building ahead of 10- and 30-year sales. Two- and five-year yields remained sharply lower until a new round of hawkish remarks from Kashkari and a Wall Street Journal article from “Fed whisperer” Nick Timiraos succeeded in tempering the rally at the front-end.

The move in the dollar was especially pronounced. Bloomberg’s gauge plunged the most in two years at one juncture, while the DXY was on track for one of its biggest single-day declines in nearly a decade (figure below).

Bets on an inter-meeting Fed hike were faded and swaps leaned back in favor of a 50bps move at the September meeting. Just 59bps of tightening was priced into next month’s gathering in the immediate aftermath of the CPI report, compared to 67bps on Tuesday. Futures-implied odds of a third consecutive 75bps hike dropped and terminal rate pricing receded.

During remarks at Drake University on Wednesday, Charles Evans said rate hikes will continue. Inflation, he remarked, is “unacceptably high” and the Fed will raise rates for the rest of 2022 and “into next year to make sure inflation gets back to our 2% objective.” The Committee, he claimed, is “well positioned for various scenarios.”

Some of the price action abated later in the session as traders digested Evans, Kashkari and Timiraos, whose efforts underscored the notion that the Fed doesn’t need or want an overzealous market. Stocks were undeterred. The S&P closed with its best gain since Powell’s press conference.

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8 thoughts on “Define Irony: Market Reaction To CPI Undermines Inflation Fight

  1. Think not just about whether you (the generic “you”, meaning we, I, investors) are bullish or bearish, but about how recent data points have incrementally changed that assessment.

    Today, YOY headline CPI declined a little and MOM headline CPI declined a lot. That’s incrementally bullish, especially if you believe that the Fed is more focused on seeing a string of cooler MOM prints than on the backward-looking 12 month YOY and that the Fed is increasingly responding to headline.

    Meanwhile, the Fed’s fist-shaking about future tightening sounds about the same as yesterday. So, not incrementally bearish.

    Net-net, incrementally bullish.

    I see H has already said this in his latest post, but the markets are not impressed with the Fed promising to do what it already promised to do.
    A downside of ostensibly retiring “forward guidance” is that it is easier for investors to dismiss what the Fed says, and focus on the data, which is, after all, what the Fed officially said it will do.

    In other words, FOMC has less power to jaw the market around. It has to DO something, or the data has to be so compelling that we’re sure they are going to DO it.

    My guess is that many equity investors can look at the softer CPI print and the modest rate action, and think “They can say whatever, but is this actually gonna trigger an emergency intra-meeting 50 bp? Naah. I’m clear until Sep 21.” [Thumb nose.]

    Also, think not just about the balance of risks you (generic “you”) see, but the timing of those risks. Market got through 2Q, next window for misses/guidedowns is 3Q i.e. October.

    Give a market a month, and he’s gonna swig a glass of milk, throw the rest in your face, and smash the glass over your head.

    1. “…about how recent data points have incrementally changed that assessment.”

      I always appreciate alternative perspectives and found this insightful, thanks for sharing.

  2. H-Man, while I agree the future (post September) does not bode well for equities, this market got the shot in the arm it wanted and will continue to push up going into September.

  3. My definition of irony – Irrational Exuberance
    An inter meeting rate hike would take a lot of wind away from the current market sales imho…
    not my base case but if markets continue to levitate another 5% in short period I could see Powell pulling the trigger while yelling (Yellen) “Damn you markets all to hell.”

    1. I personally think an inter-meeting hike would be a very good idea. Investors need to fear the Fed. Current rates are (still) very low and investors don’t believe the Fed’s jawboning. Need more risk, more unpredictability. Not “surprising” the market is fine if trying to keep risk premia low and asset values high; if trying to bring asset values down, need to retain the ability to surprise.

    2. Which markets? I don’t really do stocks all that much. Fed moves are wrecking bond prices, some, but rates are going up, finally, to where they need to be. My advisor called me yesterday and told me he has seen some new debt with nicer rates and wants to know if I’m interested. Sure am. I don’t spend most of my investment income so I have a predictable cash inflow that needs to be reinvested each month. With rising rates and equities down, the writing is on the wall for me. Keep those rates going for a while. Also, the falling prices on low rate outstanding bonds are making them ripe for capital gains.

  4. Agree with your analysis and if the ironic irrational market exuberance continues I would not be surprised at all by an inter meeting 75 point basis increase…who knows…Powell may be looking and reviewing specific data points that he could identify as justification for the surprise hike at this point…

NEWSROOM crewneck & prints