Stock Markets React to US CPI Report: Buying the Dip?

Key Concepts

• CPI (Consumer Price Index): A measure of the average change over time in the prices paid by urban consumers for a basket of consumer goods and services.
• Core Inflation: CPI excluding food and energy prices, considered a better indicator of underlying inflation trends.
• NFP (Non-Farm Payroll): A monthly report detailing the number of jobs added or lost in the US economy, excluding farm employment.
• Dovish/Hawkish (Monetary Policy): Dovish refers to a monetary policy stance favoring lower interest rates to stimulate economic growth; hawkish favors higher rates to control inflation.
• Yield Curve: A line that plots the interest rates (yields) of bonds having equal credit quality but differing maturity dates.
• Basis Points: A unit of measurement used in finance to describe the percentage change in an interest rate or yield (1 basis point = 0.01%).
• Nowcast: A real-time forecasting method that uses high-frequency data to provide current estimates of economic indicators.
• Tariff Rebase: The effect of previously implemented tariffs dropping out of the year-over-year CPI calculation after 12 months.

Market Reaction to US Economic Data & Central Bank Announcements

The markets experienced a modest rebound following the release of US CPI data, with the S&P up 0.63% and NASDAQ up 1.26%. However, these gains were tempered, as both indices had risen significantly earlier in the day before retreating. The yield curve shifted downwards (7-8/10 of a percent at the long end, 7/10 at the 2-year), indicating a more dovish outlook, but the overall response was described as “soggy.” Gold, the Euro, and the Pound remained largely flat despite policy announcements from the ECB and Bank of England. The Yen was also flat ahead of the Bank of Japan’s upcoming monetary policy announcement, with expectations of a rate hike to 0.75% today and 1.00% next year. Bitcoin declined almost 8/10 of a percent, reflecting a generally weak sentiment.

CPI Data Analysis & Implications

The released CPI data showed inflation lower than expected: core inflation at 2.6% year-on-year (vs. 3% expected) and headline inflation at 2.7% (vs. 3% expected). While this is encouraging, the majority of inflation continues to reside in the service sector, contributing 1.84% to the overall 2.7% figure. Goods inflation, previously a downward force on inflation, is now a slight positive due to tariffs.

A key point highlighted is the impact of the US government shutdown in October, which prevented the collection of October CPI data. This creates a distortion in the year-over-year comparisons. The decline in core inflation is more significant than the decline in headline inflation, suggesting that service sector inflation is moderating. Breaking down CPI into goods, services, and housing, the data shows housing declining, services moderating, and goods inflation flatlining due to tariffs.

The Federal Reserve’s argument centers around the idea that the impact of tariffs will fall out of the year-over-year CPI calculations by November 2024, leading to a rebasing of goods inflation. They anticipate that by April 2026, the reference point will be April 2025, where the majority of tariffs will be in effect, and thus shouldn’t significantly impact CPI unless markets and consumers expect the tariffs to continue.

Labor Market Data & Fed Policy Disconnect

The recent jobs data, covering November, October (with a large 105k loss reported), and revisions for September and August, showed a weaker labor market than the Fed’s benchmark of 40,000 jobs per month. The data suggests an average job loss of 50,000 per month over the four-month period, exceeding the Fed’s estimated overcount of 60,000, resulting in a real loss of approximately 50,000 jobs per month. However, considering the entire year (January-November), the average job loss is only around 5,000 per month.

Despite the weaker labor market data and lower inflation, the Federal Reserve’s stance at its recent meeting was perceived as disappointing by the markets. Chair Powell indicated a “wait and see” approach, suggesting the Fed is comfortable with current rates and lacks a clear bias. This contrasts with market expectations for more aggressive rate cuts. The market currently anticipates only a 26.6% probability of a rate cut in January, and expects 61 basis points of cuts next year, significantly more than the single cut endorsed by the Fed.

The disconnect between the Fed’s outlook and market expectations is illustrated by the S&P 500’s reaction to Fed meetings and NFP releases: each event was followed by a “wipeout” in the market. Powell’s statements – “You all seem to think we’re on some sort of autopilot. Let me disabuse you of that notion” and “we feel like we’re near neutral. We’re comfortable here. We’re not in a hurry and we don’t have any bias” – reinforced this lack of conviction.

Data Reliability Concerns & Future Outlook

Concerns were raised about the reliability of the recent CPI data due to the government shutdown and its impact on data collection. The current CPI data significantly deviates from the Cleveland Fed’s Nowcast, with the largest disconnect for core CPI since February 2020 (during COVID lockdowns). This raises questions about the accuracy of the reported inflation figures.

Looking ahead, with limited economic data scheduled during the year-end holidays and thin liquidity, the path of least resistance may be towards increased volatility and a risk-off bias. The speaker suggests a potentially “hairy” exposure situation.

Portfolio Positioning

The speaker’s current portfolio positioning includes:

• Long Gold: Maintaining a long position in gold, despite its lack of movement today.
• Dollar Exposure: Both long and short positions in the dollar, short the Australian dollar (Aussie) and long the Euro and Pound.
• Brazilian Markets: Long positions in Brazilian markets, with a significant portion of the position already taken profit on.
• MSOS (Cannabis Stocks): A long position in cannabis stocks, taking a 25% haircut today due to the White House’s announcement regarding rescheduling cannabis from Schedule I to Schedule III.
• Risk-Off Bias: Short risk via put verticals in IBIT (Bitcoin ETF), IWM (Russell 2000), NASDAQ, and S&P 500, anticipating a continued risk-off environment into February.

Notable Quotes

• “We seemingly have all the evidence that markets might want. We have a weak labor market. We have a weaker CPI report. So all the ingredients for the Fed to get dovish are there.” – Spac, summarizing the favorable data for a more dovish Fed policy.
• “You all seem to think we’re on some sort of autopilot. Let me disabuse you of that notion.” – Jerome Powell, Federal Reserve Chair, emphasizing the Fed’s lack of commitment to a pre-determined path.
• “We feel like we’re near neutral. We’re comfortable here. We’re not in a hurry and we don’t have any bias.” – Jerome Powell, highlighting the Fed’s cautious approach and lack of urgency to cut rates.

Conclusion

The recent economic data, including lower-than-expected CPI and a weakening labor market, presented a seemingly favorable environment for a more dovish Federal Reserve. However, the Fed’s cautious stance and lack of commitment to rate cuts have left the markets disappointed and created a disconnect between expectations and reality. Concerns about data reliability, stemming from the government shutdown, further complicate the outlook. The speaker anticipates continued volatility and a risk-off bias in the near term, reflected in their portfolio positioning. The lack of significant economic data during the holiday season could exacerbate these trends.