The Consumer Price Index (CPI) report for September extended a stabilizing trend for core inflation. Year-over-year, the change in the Consumer Price Index, less food and energy, has come in at 3.3%, 3.2%, 3.3%, and 3.3% over the last 4 months. If recent correlations hold, this CPI report suggests core PCE will also remain flattish on the basis of year-over-year change. PCE is the inflation measure the Fed uses to drive monetary policy. Accordingly (and anecdotally), excited talk on financial media about the potential for another 50 basis point rate cut has all but ended. Reality seems to be settling on a 25 basis point cut in November according to CME FedWatch.

The chart below shows the change in PCE in the red (and lower) line. The change in the CPI is in the blue (and higher) line.

(Click on image to enlarge)

Sources: U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items Less Food and Energy in U.S. City Average [CPILFESL], retrieved from FRED, Federal Reserve Bank of St. Louis, October 10, 2024. U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis, October 10, 2024.

Who is paying attention to the stabilizing trend n core inflation? The stabilization started ahead of the Fed’s 50 basis points rate cut on September 18th. The giddy anticipation of that rate cut dominated sentiment. Since then, the market has become relatively more certain about a 25 basis point cut in November.

Long-term bod yields fell going in to the Fed meeting but have since shot nearly straight up. Same for the U.S. dollar. The iShares 20+ Year Treasury Bond ETF (TLT) fell again in response to the CPI report, and the U.S. dollar gained marginally. So the bond and currency markets may start anticipating a longer-lasting stabilization trend. Note how TLT has come straight down except for a one week pause above support at its 50-day moving average (DMA) (the red line below).

(Click on image to enlarge)

Source: TradingView

During this time, the U.S. dollar index (DXY) first bottomed and then shot straight up for much of October.

(Click on image to enlarge)

Source: TradingView

While both shorting bonds and going long the dollar have been profitable trades, the most interesting trading action sits with the S&P 500 (SPY). Despite rising long-term bond yields, the index managed to break out to a fresh all-time high. The September CPI report barely knocked the index off its all-time high. The S&P 500 seems to have a mind of its own and is hardly paying attention to much at all over time. Even the recent increase in the volatility index (VIX) has barely fazed the S&P 500. Moreover, this strengthening bullish appearance is happening during a time which represents the third of the stock market’s most dangerous months.

Source: TradingVIew

In other words, while stabilizing inflation could dampen the trajectory for rate cuts, the S&P 500 seems to be on a near one-way track higher going into the November Presidential elections and year-end. Cause and effect across financial instruments seems quite muted. Or maybe stock traders and investors are straining to make the case that stabilization will soon give way to a resumption of a downtrend in inflation. Either way, it is not clear who is paying attention to stabilizing core inflation.

As long as these broken correlations persist, I prefer to just follow the current trends: fade TLT rallies, buy dips in the U.S. dollar, and, yes, buy the S&P 500 (I am currently hedged with a SPY put spread).

Be careful out there!

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