Less inflation = more elation

Stocks rocketed higher yesterday after a softer than expected inflation figure awoke the bulls. Bonds yields dropped, the dollar dropped, and growth stocks ascended.

Party like it’s 2020! It was one of those weeks. The market air was thick with tension. Buyers had itchy trigger fingers having abandoned their buy the dip go-to strategies in response to… well sharp pains throughout the warmer months in the northern hemisphere. Earlier this month, the Fed inserted some quirky terminology in its policy statement that could have been read as being… less hawkish. The Chairman, however, was quick to quash any hopes of relent from the central bank. That sent the nascent bulls back out to pasture. Markets would have to wait until December and hope for some more clarification from the FOMC. In the interim, a slew of informative economic indicators would be the only source of clues on what the brake-mashing Fed might do. So, we watched…and waited.

While we waited, I wrote about Fed terminology, my daughter’s new puppy, mid-term elections, corporate earnings, and the strong but showing signs of weakening labor market, amongst other things. All of these, including pokey little puppy Eloise, were relevant to the forces driving market volatility and how to handle it. After yesterday's Consumer Price Index / CPI release, we need to possibly revisit some of those topics.

Let’s start with terminology, that’s the biggie. We looked back on some oldies but focused on a new idea, the terminal rate, which is the Fed Funds rate at which the FOMC will stop hiking. Before that could happen, we would have to get a sign that the Fed would pivot from its current pace of hiking to something less aggressive, or even, though not likely, cutting rates. What might cause that pivot? A recession would certainly cause the Fed to ease off the brakes as would a significant uptick in the unemployment rate. Recalling what all this hiking is about in the first place, a downtick in inflation would be a really good reason for the Fed pull out of its dive. Yesterday, we got perhaps, the most decisive signal that inflation may be retreating to date. Now, to be clear, there is no reason to throw a party over a still-too-high +7.7% inflation rate, but it did tick lower from last month’s reading, and it was softer than expected. In recent months, markets have become more accustomed to being negatively surprised, so even a slight bit of positive news was welcomed by the capital markets. The eye of the market is back on the potential pivot. On our newly introduced term terminal rate, the market was quick to adjust expectation of that to just below 5%, possibly in May 2023. Just days ago, the number was firmly above 5% in June of 2023. According to Fed Funds futures, within the past few weeks, they were predicting a 100% probability of a +50 basis-point rate hike with a good chance of a +75 basis-point bump. After yesterday's number, the probability of a +25 basis-point hike in December is 100% with a 99% chance of a +50 basis-point addition. I would call that a half-percentage-point move with a low probability of a ¾ point adjustment.

With mid-term election results still not set in stone, the likely outcome appears to have mixed, but narrow control over Congress, which, believe it or not, is favored by the markets, and backed up by history. Though we may not know the exact numbers until next month’s runoff in Georgia, the election seems to be behind us. Corporate earnings season is wrapping up and the results were lackluster with many companies experiencing revenue growth pressure. Companies were generally anticipating a tough couple of quarters ahead and have instated cost-cutting measures with lots of focus on workforce reductions, which are likely to become evident in the important labor numbers in the months ahead. Yesterday’s increased likelihood of a sooner-than-expected pivot caused bond yields to drop which was followed by a drop in the dollar. Both of these were big contributors to the breakneck rally in growth stocks yesterday. Back to my daughter’s new puppy. She is making fantastic progress on the housebreaking front. She now manages to find her potty-pad more often than not and she has learned to appreciate the power of her bark. Looking at the numbers, I first reported to you that Ella’s potty-pad success was less than 50% while now I would say she is at a solid 60%. What does that mean for my daughters once-spotless hardwood floors? A lot more patience will be needed, because this pint-sized, happy hound is not quite there yet. Similarly, yesterday’s market elation was understandable given the buildup in tension, but we still have a long row to hoe with inflation… or for a bona fide pivot from the Fed. Stay vigilant… for your floor’s sake, if nothing else.

YESTERDAY’S MARKETS

Stocks surged yesterday on a softer than expected print in the CPI. The S&P500 gained +5.54%, the Dow Jones Industrial Average climbed by +3.70%, the Nasdaq Composite hurtled higher by +7.35%, and the Russell 2000 Index jumped by +6.11%. Bonds gained and 10-year Treasury Note yields dropped by -27 basis points to 3.81%. Cryptos recovered by +12.93% and Bitcoin advanced by +13.2%.

NEXT UP

• University of Michigan Sentiment (November) is expected to have fallen to 59.5 from 59.9. A key component of the release is 1-year Inflation Expectations, which may have ticked higher to +5.1% from last month’s +5.0%. Traders will focus on that component this morning.
• The week ahead: More earnings with a spotlight on retailers. Additionally, we will get housing numbers, Producer Price Index / PPI, Retail Sales, Industrial Production, and Leading Economic Indicators.
• The Bond Markets are closed today in observance of Veteran’s Day.