US inflation came in line with expectations. The kneejerk market reaction to the data was surprisingly negative, but the major US stock indices extended rally, while the US dollar dropped sharply.
Why was the kneejerk reaction bad?
Because investors were expecting nothing but a softer-than-expected figure; the hidden expectation was a read below 6.5% for the headline CPI, and a negative number for the monthly core CPI.
That didn’t happen.
Still, inflation eased. And it eased for the 6th straight month, from 9.1% in summer to 6.5% to the end of the year. During this time, the US jobs market remained tight. So, tight that the US economy added 4.5 million jobs in a year, and the unemployment rate fell to 3.5% in December.
We will see.
Looking closely into the data, services and food costs, which make inflation stickier and give a headache to the Fed rose; services inflation even soared to the highest levels since September 1982. That’s not good news.
Shelter inflation recorded its largest advance since 1990s. That’s also not great news – although it is said that shelter costs now overstate inflation and is the reason why core CPI accelerated on monthly basis, and there are some lag effects which would fade in the coming months.
Decline in energy prices, on the other hand, explained a part of the easing in inflation, thanks to lower gasoline prices, but energy, especially natural gas and electricity costs didn’t retreat. On the contrary, electricity prices rose nearly 15% over a year, while nat gas prices rose 20%!
This, to me, is the major risk to the future inflation prints, as the Chinese reopening should further boost energy prices, hence inflation in the coming months.
This is also why I don’t expect inflation to continue easing smoothly this year.
25bp is almost certain
All things said, the latest CPI update justifies a 25bp hike from the Federal Reserve (Fed) in February, although the tight jobs market will certainly make the rate hike discussion heated at the heart of the FOMC.
The market’s position is clear. Activity on Fed funds futures now assesses more than 95% chance for a 25bp hike.
The latter, however, doesn’t change the fact that the Fed will continue saying that they will push the rates above the 5% mark.
Whether investors believe them is a completely other story.
Despite the negative kneejerk reaction, the S&P500 and Nasdaq both closed the day higher following CPI data in line with expectations.
The S&P500 ended the day 0.34% higher, and at a very important technical level: the index is now testing the ceiling of the 2022 bearish trend and the 200-DMA to the upside.
The 200-DMA has not been broken since April 2022, and has, so far, acted as a sign to sell the top. It could take more (…better-than-expected earnings) to clear resistance around 3990-4000 range.
Earnings expectations are low, but low expectations are easier to beat
According to FactSet, the S&P500 companies could post earnings growth of -4.1% for the Q4.
Energy companies and tech stocks are an exception to this, of course. Energy companies will likely reveal another excellent quarter due to high energy prices, while tech stocks will likely deliver their second straight quarter of negative growth, with a decent 9.5% contraction expected across the sector.
But don’t forget that high expectations are difficult to beat, while low expectations are easier to beat, and the prices move according to where the results fall compared to expectations.
Today, big US banks including JP Morgan, Citigroup, Bank of New York, Bank of America and Wells Fargo will reveal their Q4 results. The US financial sector is also expected to post negative earnings growth for last quarter.
Even higher interest rates are good for interest income, a too-rapid rise in the rates threatens credit quality, loan growth, and net interest margins.