Reacting to CPI: Ignore the Spin and Don't Panic

Yesterday, before the CPI numbers for March were known, I wrote a piece that laid out why I thought traders should be assuming that the Fed would be looking at “fewer and later” rather than “sooner and greater” when it comes to rate cuts this year. Now, after the numbers, I feel fully vindicated.

The point of that article was that commodity prices rose quite sharply last month, which might have been a result, or a cause, of inflationary pressure but either way, it meant that inflationary pressure existed in the US economy. A second consecutive miss of expectations on CPI and a third consecutive increase in the month on month number shows that was indeed the case.

However, once a number comes out, I am more interested in analyzing the reaction to it in the futures market than drilling down too deep into the report itself. There are two main reasons for that.

The first is simple enough: the market reaction is what really matters to traders and investors. Our fortunes depend on the actual market price of the securities we own, not what theory or our opinions tell us that price should be. That is an important concept to keep in mind whenever investing or trading. If the market says you are wrong, you are wrong.

One of my first bosses in the interbank spot FX market used to say that saying “This should be higher/lower” was a fireable offense. I once asked him why he took that harsh line. He said, “Nobody cares where you think the market should be and certainly nobody trades based on your opinion, so shut up and deal with reality rather than wasting time whining.”

That was sound advice then, and it still is now, particularly when it comes to how the market reacts to economic news and data. The basic point was that our opinions couldn’t be trusted because, no matter how hard we tried to be unbiased, they were subjective.

That brings us to the second reason I trust market reactions rather than opinions when looking at a data release: If we look deep enough into any report on economic conditions, we can always find something that supports our preconceptions and biases. That is evident after every CPI report at the moment.

CNBC, in what I suppose they believe is an attempt to be even-handed, usually has a panel of analysts that includes one economist from a left-wing think tank, and one from the right. Their starkly different takes on what should be an empirical view of economic conditions would be comical if it weren’t so damaging to people’s understanding of the reports.

This morning, for example, the right wing analyst told us that inflation was still a massive problem and would continue to be so, while hinting that it was Joe Biden’s fault. CNBC’s presenter, Rick Santelli, even went as far as to “report” on the actual index number, which he breathlessly announced was at its highest since its inception in 1913!

I have news for you, Rick: We live in an economy that is designed to be inflationary. The index increases over time as sure as eggs are eggs, and a significant drop in the index, such as happened in the 1930’s for example, would be a major cause for concern. That so-called reporting may suit your political agenda, but it is insulting to anyone who has even a basic knowledge of economics.

Meanwhile, the analyst representing the left dug deep into the breakdown by sector of the economy to suggest that there wasn’t a problem at all. That too is unhelpful at best. The Fed has a target of 2% inflation, we are currently running above 3%, and the last three months have seen the inflation rate increase. Finding good news in that report to support a “Biden has this under control” narrative is an exercise in newspeak that is as insulting as saying that it's all Biden's fault.

When we look past the spin, what we see is that inflation is proving to be more stubborn than many people, most notably the Fed, anticipated it would be. The initial progress that brought the rate down from its 9.1% high was spectacular, but that was the easy part. What matters now is that the Fed understands that and doesn’t rush to cut. The market, based on the initial reaction to the numbers, is all too aware of that, and traders don’t seem to see it as a forlorn situation.

Futures dropped significantly at 8:30 when the CPI report was released, but the index opened only around 1% lower. That is not too drastic for an index that has returned well over 9% in the first few months of this year, and suggests that traders are waiting for earnings season, which begins in earnest on Friday with some big bank reports, before evaluating these numbers.

As I have recently written, there is a growing feeling in the market that if current conditions, with slow but steady growth, good corporate profits, and a firm jobs market are maintained, maybe no cuts this year wouldn’t be too bad.

From that perspective, a 3.5% Month on Month print for headline inflation is not really a cause for concern. For those of us who lived and traded through the inflationary years of the 1980s, a small increase in CPI is consistent with the bumpy path down and is unsurprising. It is not, however, a cause for concern if the economy is otherwise healthy. It may delay the first rate cut, but does that matter if things are going okay otherwise?

As investors digest this CPI report, they should keep two things in mind. The first is that much of the “analysis” that they will hear and read is simply political spin and can be safely ignored. The second is that a slight miss only matters in terms of its impact on the economy and corporate earnings. As long as those things are fine, the market can keep heading higher even if the last little bit of inflation above the Fed’s target proves to be hard to beat and the FOMC delays cutting rates as a result.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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