The forecasting circus continued today as market participants got yet another inflation data point to analyze. 🎪
Headline Consumer Prices (CPI) were flat MoM and decelerated to 8.5% YoY, below analyst expectations. Meanwhile, core CPI, which excludes energy and food prices, rose 0.3% MoM and 5.9% YoY, matching its June pace.
As a result of the headline number, stocks took off to the upside and rallied throughout the day. The thinking here is that if inflation has peaked and is beginning to come down, the Fed will be less aggressive in tightening, which is good for risk assets. 💭
While that narrative reigned supreme today (based on the green tape), we want to highlight a few counter-points based on what the Fed has communicated. 👇
The first is that the headline consumer price index is NOT the Fed’s preferred measure of inflation. Instead, as we’ve discussed, they prefer the Personal Consumption Expenditures Price Index (PCE), and when they look at CPI, they look at the core number.
The second is that a single-month decline does not equal a new trend. For example, inflation was 8.5% back in March and fell to 8.3% in April before reaccelerating to the upside. So if you’re going to point to any trend, it should be that core CPI decelerated for the fourth straight month (although this month’s reading was barely below last). Additionally, many of the “sticky” parts of core CPI like shelter have not shown much improvement as of yet.
The third is that the Fed literally told us it does not make decisions based on a single data point, especially one as volatile as headline CPI. They proved that to us last month by sticking with a 75 bp rate hike when the market expected a 100 bp hike following June’s record-high CPI reading. Fed Governor Evans and Kashkari were in the news today, reiterating that more rate hikes are ahead.
The fourth is that the primary driver of this drop was a decline in energy prices. Energy prices are highly volatile and impacted by geopolitical risks, industry structural issues, and a host of other factors, meaning they could just as quickly appreciate and push inflation higher. Also, many have argued that energy prices have come down due to recession fears, which would make sense given the Fed can only affect demand with its monetary policy. But we digress…
The fifth and final point is that the labor market remains extremely tight, which puts upward pressure on inflation and makes the Fed’s job much harder. Remember, the Fed’s dual mandate is full employment and long-run inflation near 2%. They told us they’re remaining aggressive until they see meaningful progress on that front…which they’ve most certainly not.
Now we’re not here trying to say whether today’s rally is warranted or not. That’s your job. 🤷♂️
We just wanted to highlight how the narrative and market reactions around certain data points can differ vastly depending on the environment. Think back to April’s “peak inflation” discussion. It differed greatly from today’s narrative, as did the market’s moves.
This highlights the difficulty of forecasting in markets. Even if you got the inflation print correct, you also had to get the market’s reaction to it correct as well to make money. Because that’s what we’re all here for, right? To make money. 💸
As Jesse Livermore said, “The stock market is never obvious. It is designed to fool most of the people, most of the time.” — seems like an appropriate reminder in these volatile times. 🤪