The ‹intra-day› turn of the S&P 500 Index following the release of US inflation data is the first evidence that Powell has deprived markets of ‹Fed hopium›.
US headline inflation rose to 3.2 per cent in July from 3.0 per cent. While that was lower than expected, it was nevertheless the first increase in the inflation level since June 2022, which (social) media used to fill headlines.
Core inflation fell from 4.8 per cent to 4.7 per cent as expected. The vast majority of core inflation is explained by ‹Owners Equivalent Rent›, which remained unchanged high at 7.7 per cent. Nobody looks at this extremely slow inflation measure anymore, which does not accurately reflect the current picture of rents.
A better alternative is the Atlanta Fed Core Sticky CPI Excluding Shelter. Inflation of goods and services that tend to change price slowly and exclude housing costs was just 0.8 per cent in the last three months annualised. Far below the Federal Reserve’s target, in other words.
The reaction
On paper, the latest US CPI report was enough to keep the bulls happy that inflation is on its way to the 2 per cent target and that further interest rate hikes are not necessary. Consequently, the initial market reaction was not unlike what we have seen this year. Share prices surged in the minutes following the announcement.
However, equities failed to sustain the rise after the inflation figures this time. After an initial rise of 0.8 per cent in the S&P 500 Index Future from the level just before publication, the future dropped 1.2 per cent until the close. So that effectively means a 0.4 per cent drop after the inflation data.
The price reaction after the July CPI data is the first hint that markets can no longer be driven by the prospect that the Federal Reserve has reached the end of the tightening cycle. The second additional rate hike is all but priced in and the likelihood of rate cuts from the start of next year is increasing.
The implications
With the demise of one of this year’s market drivers, equity markets are currently struggling to pick a direction. Earnings were good enough not to cause an immediate change in sentiment, with most investors still embracing a gradual transition as their base case.However, based on waning macro momentum over the rest of the year and the relatively slow effects of interest rate hikes by central banks due to extreme stimulus during Covid, at least some caution is in order.
Jeroen Blokland is founder of True Insights, a platform that provides independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His chart of the week appears every Monday on Investment Officer L uxembourg.