Why inflation data was no ‘watershed moment’ for stock and bond-market investors

Analysts and economists said investors in stocks and bonds who were expecting a “divergent” moment in Wednesday’s inflation data were disappointed, leaving open the debate over whether the market is close to bottoming out.

The April consumer price index was highly anticipated, and attracted the kind of pre-publication scrutiny usually reserved for articles such as the monthly employment report. Technical analyst Jeff deGraaf, founder of Renaissance Macro Research, called it one of the most anticipated CPI readings in his more than 30-year career.

And why not? Investors were looking for confirmation that inflation was finally cooling down after being at its peak in more than 40 years, beyond the career memory of the vast majority of Wall Street veterans.

In addition, the data was coming amid a sell-off of stocks and bonds that has been tough for investors in 2022 as they worried about the Federal Reserve’s ability to control inflation while avoiding the dreaded “hard landing” “of the economy.

Reads: Here are 4 reasons why market volatility is unlikely to decline any time soon, even after the US inflation rate slows to 8.3%

Perhaps the evidence of a peak in inflation would help stabilize the ship, perhaps investors were expecting, offering a clearer view of the path the Federal Reserve is taking as it raises interest rates and reduces its balance sheet by a effort to curb price pressures. .

I’ll see: Here are 4 reasons why market volatility is unlikely to decline any time soon, even after the US inflation rate slows to 8.3%

In the end, the data was a bit anticlimatic. Yes, inflation slowed, at an annual rate of 8.3% compared to the March reading of 8.6%. But it was still very hot, and above expectations for a reading of 8.1%.

More problematic for investors was basic reading, which eliminates volatile food and energy prices. It showed a 0.6% monthly increase compared to a Wall Street forecast of a 0.4% increase. The base rate hike over the past year also slowed to 6.2% from a 40-year high of 6.5% in March.

Investors don’t seem so calm. U.S. stock index futures immediately eliminated strong gains to fall ahead of the opening bell. Shares bounced higher once cash trading opened, with energy stocks leading the way as oil prices rose, but analysts struggled to identify signs that investors were leaving behind. inflation concerns.

The Dow Jones Industrial Average DJIA,
rose 34 points, or 0.1%, while the S&P 500 SPX,
which closed on Tuesday at its lowest level since March 31, 2021, below the 4,000 threshold, down 0.5%. The Nasdaq Composite COMP,
which fell in a bear market earlier this year, fell 1.7%.

Treasury bonds have also experienced a turbulent trade, but there were also signs of a turning point that would mark a lasting pause or a significant investment in the sale that brought yields to a three-and-a-half-year high this month.

“So far, at least the provisional evidence of a peak in inflation in today’s report on the US consumer price index has not been a key moment for US government bonds or shares. John Higgins, chief economist at Capital Economics, said in a statement.

“We don’t expect his fortune to improve significantly until shortly before the Fed stops tightening its policy in the summer of 2023, even as inflation falls further and the US economy experiences a” soft landing. “in the meantime,” he wrote.

The problem, analysts and investors said, is that while inflation may have peaked, the slowdown was not enough to clarify what the Fed will have to do to control price pressures in the coming months. Last week, the central bank raised its federal funds rate by 50 basis points, or half a percentage point, the largest in more than 20 years, with the Fed typically moving in quarter-point increments.

Fed Chairman Jerome Powell said there were half-point moves on the table for the next two political meetings, but poured cold water on speculation about the possibility of a move even larger than 75 basic points. Now, some analysts are thinking about the potential for a change of tune that could make a three-quarter point move back into the frame.

“If inflation stays that hot, we expect the Fed to continue to take a hard line on rate hikes. As we have seen, this can be a hard pill for investors to swallow,” said Callie Cox, an analyst at eToro U.S. Investments, in Email Comments.

He argued that with consumer and business demand still strong, policymakers have room for a “soft landing”. But stocks and cryptocurrencies “may have a hard time finding funds until we see more evidence of Fed control,” Cox said. “That particular sale could be closer to the bottom than the top. You just have to get out of the storm.”

As for the historical record, Higgins said it is far from certain that stocks or bonds would turn the corner even if data for the coming months show that inflation continues to slow. His fortunes – and those of other assets – have fluctuated four times since 1960 after high inflation in the US peaked, he said, reflecting a combination of the Fed’s response, its effect on the economy and its valuations (see chart below).

Capital economy

Higgins said the poor performance of 10-year Treasury bonds in the first 12 months after inflation peaked in 1980 coincided with the adoption of an even stricter Fed policy, with its yield maximum in the summer of 1981, around the time the federal funds rate. it began to shrink from a peak not far from 20% before that spring.

“Similarly, the weak showing of US equities in the 12-month period after inflation peaked at the time reflected the delayed influence of the Fed’s even more restrictive policy on the economy. which experienced a very deep recession between July 1981 and November 1982, “Higgins said. he wrote.

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