Meeting Expectations is Good Enough

This morning, in the immediate aftermath of the highly anticipated CPI report, I received a series of news alerts on my phone.  One was a “glass half-full” message, another was “glass half-empty”.  Any guesses about how the stock market interpreted the data?

Glass half-empty: “Core inflation rose by the most in six months in July as price pressures remained sticky.”  (Yahoo Finance)

Glass half-full: “Inflation remains at 2.7% in July.  Tariff effects are still modest.”  (Barron’s)

The instant market interpretation: “Stocks and bonds rose after the latest US inflation reading bolstered speculation the Fed will soon be able to cut rates.”  (Bloomberg)

Anyone who has been paying attention to stocks this year, or most of this decade, for that matter, knows that stocks don’t need much impetus to move higher.  An as-expected report was clearly sufficient.  The monthly and yearly changes are reported with one digit to the right of the decimal point, so the respective 0.2% and 0.3% increases on monthly headline and core CPI were exactly in-line with consensus.  There were slight divergences on the yearly data, with the 2.7% rise on the yearly headline data coming in better than the 2.8% consensus while the 3.1% yearly rise in the core was 0.1% above the 3.0% consensus.  As long as prices didn’t seem to rise faster than expected, that was a go-ahead for another leg of the rally.

Indeed, while expectations for rate cuts solidified, it’s not as though they weren’t already lofty beforehand.  According to CME FedWatch data, there is a roughly 97% expectation for a 25 basis point cut at the FOMC’s meeting on September 17^th.  But that is up from about 88% yesterday.  We went from a near likelihood to an even greater likelihood.  As for the December meeting, expectations remain firm for at least two cuts, with expectations for a third rising from 29% to 45%.  In a momentum-driven, somewhat euphoric market, those modestly increased likelihoods are enough for a nearly 1% rise in the S&P 500 (SPX). 

Short-term rates echoed the incremental change in rate cut probabilities.  The 2-year Treasury yield fell by a quick 7bp immediately after the CPI report but settled into a 4bp dip by midday.  Longer rates offered a bit of a head-fake, however.  The 10- and 30-year yields each dropped by about 3bp right after the number but reversed to 2bp and 4bp rises shortly thereafter.  This further steepens the yield curve.  The current spread between 2- and 10-year yields has widened to about 57bp today.  That is below the brief spike to 74bp on April 9^th and below the three 60+ spikes that we have seen since then, but it is also well above the 40bp spread that started the month.  This relatively stable relationship has not moved enough to impede stocks.  Then again, neither was the inverted yield curve that prevailed for nearly two years.

We have frequently noted that momentum-driven stock markets seem to be obeying Newton’s First Law of Motion, paraphrased as: A body in motion remains in motion unless it is acted upon by an external force.  Today’s CPI report certainly was an insufficient external force to alter the current trends.

Spread Between 2- and 10-Year Treasury Yields, 6-Months, Daily Candles, with 20-Day Moving Average

Past performance is not indicative of future results. Source: Bloomberg