Stocks took a fall yesterday after inflation numbers came in higher than expected. The unexpected print all but guaranteed a bigger rate hike next week – though we probably already expected it.
Inflation, really? There used to be this ketchup commercial in the 1970s in which the entirety of the spot features the tomato condiment slowly, slowly, slowly pouring out of the then-glass bottle while the background featured the song “Anticipation” by Carly Simon. Come on, you know the one. You also know that ketchup, especially poured out of a glass bottle, does, indeed require some patience, but if you are a fan of the stuff, it is certainly worth the wait. Imagine if you were that kid in the commercial, your steaming, juicy burger laying exposed on the plate, getting cold with every second. Envision the anticipation of that ketchup finally dressing that object of your desire so that you could sink your teeth into that delectable treat. Picture if after you waited what seemed like a lifetime, a big glob of mustard landed on your now-cold burger. You would have been heartbroken as the needle scratch abruptly ended the background music. Yep, that is what happened to the anticipating stock market yesterday when the Consumer Price Index / CPI came in higher than expected. Inflation is a big deal, which is why I have dedicated so many lines of my daily note to the topic but was yesterday’s number a big deal… in the big picture? Let’s take a closer look… starting with the big picture.
Just about every morning, I report to you the probability of the Fed’s next rate hiking maneuver. Why, because I want you to be in the know about what to expect next week. Yesterday morning, there was a 93% chance of a +75 basis-point rate hike. On Wall Street, or any other street for that matter, those are pretty solid odds. Would you bring your umbrella if the weather forecast showed a 93% chance of rain? Of course, you would. Just a day earlier that large rate hike probability was at around 85%, also strong odds. In fact, anything over 50% would be worth considering as a good possibility. For the record, that probability has been greater than 50% since August 19th. Since that date, the 2-year Treasury Note yield has risen from 3.23% to 3.75%, more than a half of a percentage point. The 2-year yield attempts to project short term rates in 2 years and it is closely tied to current interest rate policy. Also, a move of that magnitude in a shorter maturity over that short period of time, is considered rather large. Of that move, nearly +20 basis points were added in yesterday's session alone. What that tells me is that the bond market was anticipating the event, having already risen by some +25 basis points leading up to yesterday morning’s print. The same, unfortunately could not be said of the stock market, which after initially falling through the end of August rallied some +5% in the 4 sessions leading up to yesterday, clearly anticipating a smaller than expected rise in consumer prices. Well, as we know, much of that 4-session rise was erased in yesterday’s trade. Reality check? For sure.
Speaking of reality, what is the reality of yesterday’s inflation number. The number that upset stocks was the headline CPI number which came in at +8.3% after economists were expecting +8.1%. Who are those economists anyway? In this case the expected number was a median of estimates from 50 economists. Of those 50, only 3 estimated CPI to come in at +8.3%, Bank of Montreal, Berliner Sparkasse, and SMBC Nikko Securities. Way to go! The other 47, who all forecasted lower inflation, either don’t shop at the grocery store… or they don’t watch the bond markets. Now, here is my sanguine take on yesterday's print. Yes, we were not surprised, but more importantly, even though economists and stock traders were surprised, the number was still lower than last month. Check out the following chart which breaks the number down. In it, you can clearly see how massive inflation kicked in during Q2 of last year. Initial gains were in energy (green bars), followed by goods (orange bars). Soon after food (mustard bars) began to grow. Goods peaked in March of this year, while energy peaked earlier this summer. Without the chart, you probably already suspected that. What you may not have suspected was that services (blue bars) have been on the climb and represent much of the recent gains in the CPI. Oh, and food, which you may also suspect, has been contributing to recent gains in inflation as well. Overall, however, you will note that inflation, appears, on aggregate to be topping off… for now. This morning, according to Fed Funds futures, there is now a 100% chance of a 75 basis-point hike with a 30% chance of a full percentage point hike. Somewhere in the early 1980s, Kraft Heinz introduced the squeeze bottle for its famous ketchup brand. Gone is that long wait and that great theme song.
YESTERDAY’S MARKETS
Stocks encountered a heavy rout yesterday after CPI surprised traders on the upside sparking fears of more oversized rate hikes. The S&P500 lost -4.32%, the Dow Jones Industrial Average traded lower by -3.94%, the Nasdaq Composite Index dropped by -5.16%, and the Russell 2000 Index declined by -3.91%. Bonds fell and 10-year Treasury Note yields climbed by +5 basis points to 3.40%. Cryptos lost -8.19% and Bitcoin declined by -9.68%.
NXT UP