The Inflation Decline Slows and the Markets Respond
February kicked off with the Fed announcing a widely expected .25 basis point hike in the Fed Funds rate. In Chairman Powell’s statement that followed, he noted that while inflation remains historically high, price expectations have moderated. He explained that future, tapered rate increases would allow primary inflation data points to catch up with reality, but made no projections as to where those increases would be paused. Stocks and bonds rose off that news, leaving the S&P 500 hovering near the upper reaches of its current trading range and the 10-year treasury near its YTD low yield of 3.40%. The release of December’s inflation data and the Fed’s response to it led some to believe a pause in rates might even be seen in Q2. Those thoughts were dashed with the release of January’s inflation scorecard.
Last week’s trifecta of inflation data raised more questions for investors than it answered. Yes, the inflation numbers, as represented by CPI (consumer prices) and PPI (wholesale prices) showed another in a months-long series of declines. Good news. However, the rate of decline had slowed appreciably and given investors pause. A day later, Retail Sales for January surprised significantly to the upside. Normally, that’s good news but not so much when battling inflation. The result? A selloff in the bond market that took the 10-year treasury yield above 3.80%, more than .40 basis points off its January low. That would be congruent with the view that the Fed will likely see this data as reason to extend rate hikes further into the year than many were thinking. Stock investors took a bit longer to digest that news before we saw the indexes edging down to the midpoint of the current trading range as the week came to a close.
The data, and the market’s reaction to it, points to a likely reassessment of the Fed’s end game and terminal rate by those optimists who thought there might be only one more .25bp rate bump in March that would precede the announcement of a pause in hikes at the May meeting. We are now left awaiting the final result of the current earnings season that, so far, can be described only as marginally positive on balance. Not great, but not bad either.
Looking ahead, the next inflation trifecta will be announced March 14-15, one week prior to the upcoming Fed meeting and announcement. There, most expect to see another .25bp increase in the Fed Funds rate while a few soap-selling TV pundits have raised the prospect of a .50bp increase. Investors and the markets aren’t buying. We would expect little change in messaging from the Fed: Inflation remains too high and may be more “sticky” than recently thought. There’s been some improvement, but more work needs to be done to reduce the labor imbalance. Depending on the data, we could see rate increases, however small, extend well into the second half of the year. Stay tuned.
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