U.S. equities whipsawed in early Tuesday trade after a key measure of U.S. consumer prices aligned with expectations in November, showing inflation slowed to a 3.1% rate in November. The Core Consumer Price Index (CPI), which excludes volatile food and energy components, increased by 0.3% from the previous month, in line with forecasts according to data from the Labor Department.
This development has fueled optimism that the Federal Reserve may not need to maintain an aggressive stance on interest-rate policies. As a result, stocks rallied in response to the November CPI data, before paring gains to trade flat on the day as traders likely used the opportunity to take some profit. The S&P 500 futures came close to tagging the 4700 mark at one point during the pre-market session on Tuesday.
The stability in core CPI suggests that inflationary pressures are in line with expectations, which may alleviate concerns about the need for the Federal Reserve to take more drastic measures. The Fed has been closely monitoring economic indicators, and the consumer price data falling within predicted ranges could influence the central bank’s decisions on future monetary policies.
Investors are sensitive to inflation data, as it significantly shapes the broader economic landscape and monetary policy decisions. The in-line core CPI figures contribute to a positive market sentiment, with hopes that the Federal Reserve can find a balanced approach to support economic growth without causing undue inflationary pressures.
Headline inflation rose 0.1% in November, just above the expected flat growth. On an annual basis, CPI increased by 3.1%, in line with expectations. While core inflation rose 0.3% on a MoM basis, it was up 4% YoY, in line with expectations.
Category-wise, the food index rose by 0.2%, following a 0.3% increase in October. The energy index decreased by 2.3% in November, smaller than a 2.5% decline last month. The shelter index, which is a metric closely watched by the Fed, increased by 0.4% in November, compared to a 0.3% rise in October.
“For the FOMC in 2024, 3.5% inflation is acceptable, recession is not,″ said Steven Blitz, chief U.S. economist at TS Lombard. “With 61% of adults owning equities, the highest since 2008, the Fed is not going to sacrifice faith in equities on the altar of 2% inflation.”
Focus Turns to FOMC
While the market acknowledges that the likelihood of additional rate hikes from the Federal Reserve is minimal, Tuesday’s CPI report and the subsequent market reaction will most likely influence Chair Powell’s tone at Wednesday’s meeting. The market sees the Fed staying on hold and maintaining its federal funds rate at 5.25-5.50%.
Inflation data remains a crucial factor in determining the potential timing for initiating rate cuts. The November data showed the persistent dynamics in shelter and core non-shelter services inflation but a softer trend in goods prices.
The continuation of services and shelter inflation suggests a later start for rate cuts compared to market expectations, with the first cut potentially occurring in the second half of the year, later than the current market consensus. This could be the key reason why the ongoing rally in risk assets may not have much upside left.
The data published since the November meeting indicates a moderation in economic activity, disinflation, and a slowdown in the labor market. This has likely bolstered the Federal Reserve’s confidence in the adequacy of its current policy stance, which Chairman Powell and his colleagues perceive as “sufficiently restrictive.”
November’s CPI report is that major piece of data before the Fed decides on Wednesday. The central bank received positive developments regarding inflation expectations last Friday after the December University of Michigan Survey of Consumer Sentiment showed significant decreases in both one-year-ahead and five-to-ten-year-ahead inflation expectations.
Consequently, future decisions by the Fed are expected to focus more on the duration of maintaining the current policy stance rather than contemplating the necessity of further tightening of policy rates.
According to the latest CNBC survey, the U.S. central bank is seeing cutting rates mid-year in 2024. Respondents anticipate the Federal Reserve initiating rate cuts next year, with the majority expecting reductions to begin around June, reaching 69% by July.
“The Fed needs to begin laying out a road map to rate cuts that may represent tighter policy since cuts will be lagging the decline in inflation and real rates will be rising,” commented John Ryding, chief economic advisor to Brean Capital.
On average, survey participants forecast approximately 85 basis points of cuts in 2024, translating to around one 25 basis point reduction per quarter. However, this projection falls short of the 120 basis points priced into futures markets. The outlook also includes an increased likelihood of a soft economic landing and lower inflation.
On the other hand, the market currently assigns a 42% probability that the Fed will cut rates in March, with this number rising to 50% for the meeting in May, according to the CME FedWatch tool. The consensus sees the fed funds rate ending the next year at 4.25-4.5%.
Summary
U.S. stock futures were mixed in early New York on Tuesday following inflation data that met expectations, fueling speculation that the Federal Reserve will maintain higher interest rates to bring inflation back to its 2% target. The central bank is due to decide on the rates tomorrow with the market fully expecting it to hold rates at current levels.
