US stocks are trading higher as investors digest a slowing yet in-line CPI print that sees the rising tide of optimism lift all boats. Markets are assuming a risk-on stance with signs of descending inflation, underscoring the peak inflation narrative as an indication that the Fed will be able to ease its monetary tightening cycle and that the US economy may even achieve the soft landing that may be just what the doctor ordered for equities.
Another relatively cordial inflation report is welcome news and could tip the scale toward the Fed dialling down the pace of rate hikes to 25 bps at the next meeting.
For a change, the CPI report was bang on the consensus call, with the headline index declining 0.1%, chopping the yearly pace to 6.5%. A nearly 10 % slide in gasoline will do that.
The bottom line is that the report will be good news for the Fed, as two out of three of Powell’s key inflation categories (core goods, shelter, and core services ex-shelter) are now moving in the right direction: down. And it is only a matter of time before the shelter component rolls over.
But alongside a softening headline CPI print, investors are also digesting better than expected weekly jobless claims — which extends the recent trend of data points indicating continued strength in the US labour market. The setup underscores a critical dynamic that could result in the Fed holding rates higher in 2023 than many anticipate. Hence palpable concern in some corners that inflation will have a second act reminiscent of a slasher movie where the villain always comes back one more time 20 minutes before the credits roll.
That said, there is no sense in dancing around the obvious: The odds now favour a step down to a 25bps hike cadence from the Fed at the next meeting, and it is possible (albeit exceptionally unlikely) that the February hike will be the last. At one point Thursday, swaps showed less than 50bps of combined hikes priced for the February and March meetings. That would suggest an outside chance that the Committee will pause in Q1.
As the inflation regime changes, so do the playbooks to position across asset classes. And barring some unexpected turn, the Fed will almost surely downshift to “regular” rate hike increments early next month. And eventually, the Committee will have to accept that stocks are sure to rally as the pause line nears, real rates will recede quite a bit, and the dollar will fall much further.
With the inflation print out of the way, the focus now shifts to the 4Q earnings season, which kicks off Friday with the big banks. For stock pickers, the obstacle is that an earnings recession could blunt the euphoria that would otherwise accompany any indication from the Fed that it is nearing the finishing line ahead of schedule.
With this year’s “shunto” springtime labour negotiation likely to result in wage growth of 3% or higher, the market lean sees BoJ ending the YCC at the very least by end-Q2, if not hiking rates above zero, with an increased risk of further adjustment to the YCC programme as soon as next week. Hence the street should continue to build USDJPY shorts, especially with a strong chance US real rates slink much lower.
On a multi-day view, a largely as-expected core CPI data point will keep the recent trends intact and play to selling any USD upticks across most G10 and Asia FX currencies in a broad-based move on expectations that “sufficiently restrictive” has been achieved ahead of schedule.
Published by Stephen Innes, Managing Partner, SPI ASSET MANAGEMENT