Inflation data day

Stocks rallied yesterday as investors awaited today’s big inflation figure. A pullback in bond yields show that investors are still not convinced that the Fed is actually hawkish.

Data dependent. Well… duh, of course the Fed is data dependent. We would certainly hope that high-powered bankers don’t just make policy decisions based on some arcane signals. Side note and true story. When I started on Wall Street there was a senior bond trader on the desk that based his daily trades on the results of a morning ritual game of Nintendo Super Mario Brothers. Now you know I can’t make that up, and you probably know where that trader ended up. Ok, back to data-dependence. The Fed often reminds us that it is data dependent, but there is some greater meaning behind it. We know that once the Fed makes a big policy pivot that it is typically committed to that regime for a while. For instance, when the Fed pivoted into hawk mode in late 2021, we knew that there would be hikes, balance sheet runoff, and nasty talk for the near future. The Fed did not take the pivot decisions lightly. Hikes would come and keep coming until a reverse pivot into dove mode. There are only 2 things which would cause a reversal of policy: 1) inflation back to normal, or 2) recession.

We knew all along that the Fed was watching the numbers, but we also knew that the Fed would not stop raising rates until they got into that restrictive zone. That zone, by the way is not strictly defined, and its boundaries vary broadly from one economists’ models to another. Ok, I am sure that doesn’t help with your investment decisions, but I am telling it like it is. So, here we are nearly 1 year after the Fed began its epic rate-hiking campaign. In a little over a month from now the FOMC will meet and make some decisions. Just a few weeks back futures predicted that March might have been the last +25 basis-point hike before a pivot. However, that has changed in recent weeks due to some stronger employment figures and some discomforting Fed speakers. After the Fed’s last policy meeting, Chairman Powell said that the Fed was data-dependent, and in this case the term meant something different. I meant that a pivot could happen at any meeting… based on the data. I know that this is highly nuanced, but people make a living out of trying to interpret the Fed’s body language. Data-dependence at this stage of the Fed’s hiking interval means that it is nearing an end if the data continues to support the shift in policy.

Of course, the Fed is looking at any credible (not Nintendo results) data that is available, but there are several key indicators that it cannot ignore. Policy makers have made it clear that employment and the labor market were one key factor in their decision making, and recent prints have not supported a dovish shift. Another one, which should be the most obvious is inflation itself. Though the Fed prefers to look at Personal Consumption Expenditure / PEC Deflator, it also watches the more broadly quoted Consumer Price Index / CPI number which is due to be released later this morning. Economists are expecting the indicator to rise month over month, but to decline year over year. That means prices are still rising, but at a slower pace. Let’s call that good but not great. Let’s also note that the Fed typically looks at the core inflation figure because it excludes energy and food prices, which tend to be volatile and make forecasting difficult. I get it, but I also chuckle every time I write it as it is the high inflation of food and energy products that caused us all so much pain in these past few years. That said, fuel costs have popped a bit in recent weeks which is a driver of the monthly increase, but that will not concern the Fed. What will concern it is if services prices continue to rise, more so if those increases are extreme and beyond expectations. Now that the Fed is data-dependent, these types of economic releases will become increasingly critical and with their releases there will be an increasing amount of market volatility… especially if they come in above or below expectations.

WHAT’S SHAKIN’

SolarEdge Technologies Inc (SEDG) shares are lower by -5.06% in the premarket after it announced that it beat EPS and Revenue estimates by +82.86% and +1.33% respectively. The reason for the decline was the companies cautious view for full year guidance, though the guidance still exceeded analyst expectations. Potential average analyst target upside: +18.3%.

Cadence Design Systems Inc (CDNS) shares are higher by +5.01% in the premarket after it announced that it beat EPS and Sales estimates by +4.52% and +1.65% respectively. Additionally, the company provided current quarter and full-year guidance that topped analysts’ estimates. The companies bullish outlook is a positive signal for the semiconductor industry, which is typically a leading indicator for tech as a whole.  Potential average analyst target upside: +9.6%.

YESTERDAY’S MARKETS

Stocks rallied yesterday as investors were hoping that a weak inflation print this morning may release the doves at the Fed. The S&P500 Index gained +1.14%, the Dow Jones Industrial Average climbed by +1.11%, The Nasdaq Composite Index jumped by +1.48%, and the Russell 2000 Index advanced by +1.16%. Bonds gained some ground and 10-year Treasury Note yields slipped by -3 basis points to 3.70%. Cryptos fell by -2.40% and Bitcoin declined by -0.51%.

NEXT UP

• Consumer Price Index / CPI (Jan) may have slowed to +6.2% from +6.5%.
• Fed Speakers: Barkin, Logan, Harker, and Williams. Also at the Fed: Lael Brainard, a dove, is expected to announce that she will be heading to the White House to become Biden’s chief economic advisor. Traders will wonder if the known dovish voice will be replaced by one with a different tone.