Asia Open: It Could Have Been Worse

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Despite February's hotter-than-expected inflation data, investors' expectations for rate cuts this year remained on track, which buoyed stocks on Tuesday.

The consumer-price index rose 3.2% in February compared to a year earlier, surpassing economists' expectations of 3.1%. Core inflation, which excludes volatile food and energy costs, also exceeded projections.

January's inflation reading had already been higher than anticipated, leading to uncertainty about when the Federal Reserve might begin cutting interest rates. However, despite another strong report in February, investors sense the Fed is looking for any reason or excuse to cut rates this election year. With another few months of data collection, rate cut probabilities suggest they will undoubtedly find that impetus.

While yesterday’s warm CPI print might be challenging to square with early rate cuts, the unrounded core print wasn’t a disaster; the June rate cut probably only nudged down 10 points but still remains above the 70 % odds on the level.

Indeed, stock market participants shrugged off yet another hotter inflation report, staying enthusiastic about June rate cuts and the unbridled prospect of AI, which, in turn, drove the S&P 500 to a new record high. The Nasdaq Composite also climbed about 1.5%, buoyed by the strength of technology stocks, particularly ( who else) Nvidia (NVDA), which saw its stock price increase by 7%.

Heading into each major US inflation release feels reminiscent of a high-stakes Texas Holdem poker game at the Bellagio, where each inflation card holds the potential to make or break. However, the unrounded core print, which was not a complete disaster and far from the market's worse-case “ whisper “ fears, injected a dose of relief into an already tense atmosphere and from there, it was back on the rally wagon.

Gasoline prices and shelter costs, particularly rents, played a significant role in driving up the monthly increase in the CPI, accounting for over 60 percent of the overall uptick. Higher gasoline prices will be a major point of contention for the White House, and I would not even rule out another SPR drain to push prices lower. However, amidst the cacophony surrounding the BLS methodology, it's possible that observers are overlooking a crucial factor: owners' equivalent rent (OER), a metric gauging the hypothetical rental income or expenses for homeowners.

The reliability of OER is under scrutiny due to substantial room for sampling error, compounded by concerns about housing affordability. This issue is precisely why the Fed is eager to find any justification for lowering rates—to alleviate pressure on mortgages and, ideally, stimulate more activity in an overheated US housing market. By doing so, the Fed aims to kickstart a virtuous cycle of deflation, wherein reduced housing costs lead to broader economic benefits.

Expectations of rate cuts and a Goldilocks macroeconomic storyline undoubtedly influence the resilience of risk assets. Still, it's crucial not to overlook the significant impact of bond markets in this equation.

The White House, through Janet Yellen's direction, has essentially changed the game plan by redirecting issuance towards Bills, which limits the term premium or, at the very least, eliminates a significant bearish catalyst for the longer end of the yield curve. With money market fund inflows showing no signs of slowing down, reaching $190 billion year-to-date and totalling $6.1 trillion in assets under management, it's expected that there will be ample demand for Bill supply. However, to cover all bases, both Waller and Powell have recently hinted at a willingness to consider shortening the Federal Reserve's balance sheet weighted average maturity (WAM), indicating a preference for shorter maturities.

It’s an election year with Yellen ( Democrat) and Powell ( Republican ) holding dovish hands in a bi-partisan fashion; the default setting for stocks appears higher.

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