US CPI Bounce Goes Unheard, Focus on Bank Earnings

Yesterday’s US inflation report wasn’t exactly ideal. The headline inflation rose more than expected to 3.4% from 3.1% printed a month earlier. Shelter, electricity, and food prices drove the overall CPI index higher in December. Especially, the shelter costs increased by more than 6%. But if you don’t count food and energy price inflation, core inflation eased to 3.9% during the same month. And well, if you start getting the shelter cost off the calculation, the numbers were quite good. Of course, the metrics that disregard food, energy and shelter prices – like the core and supercore inflation – make little sense to Mr. and Ms. Everyone, as everyone eats, everyone uses energy and everyone needs a shelter. Yet, for the Federal Reserve (Fed), these items have volatile prices, so they prefer looking past these important categories. While doing so, inflation eased. Also, note that a rise in car prices also added to the inflationary pressures last month. But their weight is lower in the calculation of the PCE index. That’s why the Fed’s favourite inflation gauge – the PCE index which will be released by the end of the month – will likely be trending closer to the 2% target.

But all in all, yesterday’s inflation report was less than ideal, and the market reaction was mixed. The US 2 and 10-year first rose then fell, whereas you would expect a swift shift in dovish Fed expectations following a bigger-than-expected jump in US headline inflation. The equities were up and down, and the S&P500 closed the session very slightly in the negative while Nasdaq eked out even a small gain at yesterday’s close.

Disinflation remains the base case scenario for this year, housing costs are expected to fall – at some point – and that could counterweight the rising shipping costs caused by the Red Sea tensions and low water levels in the Panama Canal that also threaten food deflation that we saw last year. Yet some hawkish voices are rising at the Fed, at the start of this year. Fed’s Loretta Mester said that it’s probably too early to cut rates. Mr. Barkin also repeated that he’s looking for more evidence that inflation is headed toward the 2% target.

But it’s obvious that investors are not willing to trade the bad smell for now.

The US dollar index is under pressure after yet a stronger-than-expected inflation report, the EURUSD rebounded lower after hitting the 1.10 mark, as the euro bulls, or the dollar bears found no reasonable conviction to carry the rally above the 1.10 mark, and gold rebounded after hitting the 50-DMA, near $2013 per ounce. Activity on Fed funds futures still gives more than 70% chance for the first Fed rate hike to happen in March. But the Fed won’t find enough evidence that inflation will ease toward the 2% target as early as March. Consequently, there should be a readjustment in market expectations, and we will see the stock and bond prices make a corrective move to the downside.

Earnings season kicks off

Over the next few weeks, attention will be directed toward company earnings, and we will start digesting the earnings starting from the financial sector. The SPDR’s financials closed last year with more than a 20% rally thanks to optimism that the Fed would start cutting the interest rates sooner rather than later. The massive rebound in US long-term papers had a substantial positive impact on their balance sheets. Yet expectations for the US banks are not necessarily positive. First, the banks are expected to announce a 21% decline in their profits compared to the same period last year, as a result of higher costs to attract and maintain deposits in an environment of high inflation and higher Fed rates. Then, credit card delinquencies continue to rise. US consumer spending remained robust yet … people are not buying stuff that they can afford. The bad loans are therefore expected to be on the rise. On the corporate side, investment banking revenues will likely remain weak given that the M&A activity was subdued last year. And well, if the Fed starts cutting the interest rates and the economy slows, the banks will start seeing their net profit margin shrink. Therefore, the FactSet projections indicate that the S&P500’s financial sector could reveal the 4th highest yoy earnings decline among all 11 sectors for Q4, with an estimated downturn of -3.1%. If that’s the case, a correction in the S&P500 financials would only make sense after a more than 20% rally recorded in just two months. Anyway, I stop here and let the bank earnings tell the story.

Same story, different day

In energy, crude oil rebounded 2% yesterday and is better bid this morning on the back of rising tensions in the Red Sea. This time the news that Iran captured an oil tanker off the cost of Oman is pushing prices higher. Yet the Red Sea tensions have so far been insufficient to push the price of a barrel sustainably higher. Therefore, price rallies into and above the $75pb level could be interesting top selling opportunities for those willing to see the price of a barrel fall below the $70pb level.

On the corporate level, consolidation in the US energy sector is now shifting toward the nat gas companies. Chesapeake Energy agreed to merge with Southwestern Energy Company in an all-stock transaction worth $7.4bn. Chesapeake’s price rose 3% while Southwestern Energy lost 2.5%, and efficiencies could support a further correction for Chesapeake.

Nat gas futures have been rising in the US, yet the European TTF futures continue to fall despite snow and harsh winter weather. It is because the European gas storage is so full that some say that winter is already over in the gas market.