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MARKETS

Wall Street stocks showed little change on Thursday as investors looked through disappointing US headline inflation data. The data had been eagerly awaited for its implications on potential Federal Reserve interest rate cuts. Still, little was actually gleaned, with the bond market exhibiting its new-found calmness and US 10-year yields ending below 4 % on the day. Sub 4 % yield on the keenly watched 10-year benchmark is ostensibly positive for risk in this highly rate-sensitive environment.

So, after a yo-yo session, the broader markets ended flat, more or less.

If the aggressive interest rate easing markets have priced in for 2024 is to materialize, contrary to what Federal Reserve officials are currently signalling, data like yesterday's may need to prove much softer, even at the headline level, to help propel the S&P 500 to record levels.

While the US inflation report ran moderately warm, there is too much ambiguity in the various inflation gauges to push back on the Federal Reserve’s mechanical 75 bp rate cut narrative (i.e., if inflation falls, rate cuts are following).

Let's agree that the market is less concerned with the economic realities of folks getting gouged for rent and food but solely focused on the Federal Reserve policy response. In that case, the headline print matters less than the signals buried in the ‘super core’ detail.

The headline, all-items gauge increased by 0.3% last month compared to November. The increases in the electricity and gasoline indexes offset a decline in natural gas prices, contributing to the uptick in the energy gauge. Shelter costs were the primary driver of more than half of the month-to-month increase in the headline index.

On a positive note, the CPI-derived "supercore" measures, which the Federal Reserve closely monitors, showed lower month-on-month increases in December compared to the previous month. Core services excluding shelter increased by 0.406% (down from 0.51%), and core services excluding rent and owner's equivalent rent rose by 0.403% (slightly down from 0.44%).

In essence, the data did not significantly change the Federal Reserve narrative. And it wasn't anticipated to do so. Ultimately, the December CPI release did not provide a strong argument for a March rate cut, and there is likely no sense of urgency from the Federal Reserve as the headline prints will allow them to beat the "job not done" drum.

Simultaneously, nothing in the release should sound alarm bells in the halls of the Federal Reserve unless one considers that core inflation is still running double the target. Which, of course, doesn't support the maximal rosy outlook on inflation signalled by the 5 or more rate cuts stance some investors have adopted.

In summary, this release alone is unlikely to prompt significant shifts in prevailing narratives as there is simply too much dubiety in the various inflation gauges. Rate cuts are still on the table; nobody knows when the Federal Reserve will start or the frequency and speed of those cuts. I'm pencilling in June.

Ultimately, we are back to the critical question of how the gap between market-based rate cut expectations and the Federal Reserve projections will be reconciled.

Still, with renewed concerns on the supply side, especially oil prices, due to geopolitical events amid the prospect of rising asset prices re-fueling inflation pressure, they have likely left some investors apprehensive about the potential for another year of persistently elevated prices.

Something tells me the final mile to reach 2 % inflation nirvana will be a torturously bumpy one for risk-takers. While not the best outlook for investors, it would certainly be music to traders’ ears.

With CPI out of the way, the focus turns to PPI. In addition, investors will be gearing up for the fourth-quarter earnings season to commence in earnest on Friday, with reports from JPMorgan and others set to be released.

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