December's CPI report to set stage for coming Fed moves
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As the Federal Reserve has ratcheted up interest rates, inflation has started to cool, according to recent economic reports. Most recently, wage growth rose less than expected in the December nonfarm payrolls report, giving further assurance that a wage-price spiral has not developed.
On Thursday, investors will see if that trend is continuing when the Department of Labor issues the December Consumer Price Index. Headline inflation is expected to rise 6.5% Y/Y in December, easing from 7.1% in November. Core CPI, which excludes volatile food and energy prices, is expected to increase 5.7% vs. 6.0% in the previous month. But now a new term has emerged for market watchers to focus on — super core inflation.
Fed Chair Jerome Powell's mentioned at his December press conference that the services component of inflation, excluding housing, was particularly concerning as that tends to be more persistent than goods prices. San Francisco Fed President Mary Daly also said that the non-housing services inflation is something to keep an eye on.
Market participants will be looking at "super core" measures, 22V Research's Dennis DeBusschere said. The previous three-month annualized rate of "super core" inflation was 4.3%, and the headline Y/Y rate was 7.1%, he noted. "If 'super core' comes in below that, it will be risk-on," and he'll expect markets to ignore the Fed's hawkish commentary.
How market participants react to the report will depend on what they expect the Federal Reserve will do in response to the report. A much cooler than expected reading may have some traders expecting the Fed to stop raising interest rates. Keep in mind, though, that the Fed policymakers generally give more weight to core personal consumption expenditures (PCE), rather than the CPI.
Jim Baird, chief investment officer at Plante Moran, a consulting and wealth management firm, said lower inflation alone won't convince the Fed to adjust its policy path, "particularly given the persistent tightness in labor market indicators." With the unemployment rate and layoffs remaining low and job openings still high, a "more meaningful softening in labor demand and wage growth will be needed," he said. "Labor conditions have weakened over the past year, but remain too robust for the Fed's liking."
Soon after the Fed's December meeting, Daly said the economy has good momentum and is starting to respond to the central bank's tightening policy, but it's still "far away" from its price stability goal of 2%. Keeping the policy rate at its peak for 11 months "is a reasonable starting point," she added.
Interactive Brokers Senior Economist José Torres sees the potential for the S&P 500 to rally to 4000 after tomorrow CPI, but it could be short-lived. "Markets are likely to be challenged," he said. Later this week, companies start reporting Q4 2022 earnings.
"Earnings and guidance are likely to disappoint against the backdrop of overly optimistic expectations" and "valuations remain stretched when compared to attractive yields in the fixed-income complex," Torres said. In addition, he sees technicals as as a "headwind with the 200-day moving average and the 12.5- month "downtrend line hovering right around 4000."
SA contributor Damir Tokic also sees the bear market likely continuing as it's unlikely that inflation will fall to 2% without a recession.
On Monday, SA contributor Logan Kane said investors are optimistic about Thursday's CPI report, "but history and econometric models continue to suggest that inflation is not yet conquered." He expects the Fed at its next meeting to raise rates by 25 basis points if CPI comes in cooler than expected and by 50 bps if it comes in hotter than consensus.
Another SA contributor, Mott Capital Management, says inflation may not be conquered yet, pointing out that commodity prices are rising as the dollar weakens and China re-opens.