Regular readers will know that while I do pay attention to economic data, what usually interests me more is how the market reacts to the release of those numbers. Sometimes it is predictable. A stronger jobs report than anticipated is usually a good thing, as is better than expected GDP growth. Meanwhile, things like higher than forecast inflation are bad, and the market typically responds accordingly. Where it gets interesting, though, is when you get a report like this morning’s CPI, where the key number is in line with analysts’ expectations, but the market still moves.
The headline inflation number came in at a 5.0% annual rate and 0.1% month-on-month, both marginally better than expected. However, core inflation, which strips out volatile food and energy prices and is the preferred number of most analysts, including those at the Fed, was exactly in line with the forecast 5.6% year-on-year and 0.4% month-on-month. Those somewhat neutral looking numbers, though, produced an anything but neutral initial response, both in equities and Treasuries.
Equity futures like the E-Mini S&P 500 contract shown above, jumped. Meanwhile, the 2-year Treasury yield dropped significantly, and more importantly, the yield curve flattened noticeably as yields further out the curve were little changed or even reacted slightly positively. Yield curve inversion, which is what we have seen for quite a long time now, is known to be an indicator of a coming recession, so a significant reduction in the degree of inversion is a good sign.
All in all, this “as expected” report was received by the market as extremely good news. That is puzzling in some ways, but there is an explanation for it that is significant, and that tells investors a lot about what to expect in the coming months.
The last few days of trading, indeed the last month or so, have been positive in equities, suggesting that there was no great trepidation going into this morning’s release. So, this is not a relief rally. Rather it is about a market looking for the positive in what looks like an unsurprising and unexciting CPI report. With the next few weeks being earnings season, that is important. All numbers are open to interpretation, and a market in a bullish mood will default towards a positive take on even so-so earnings reports and see every beat as a good thing without necessarily applying historical context.
On average, around 65-70% of S&P 500 companies beat expectations on the bottom line. That is a ridiculous number, but it is a product of the tendency of both CEOs to try to under promise and over deliver, and of Wall Street analysts to rely so heavily on forward guidance issued by those bosses. Normally, of course, traders understand all that and take moderate beats in their stride, but if the default is to react positively, even small beats of downgraded expectations will be seen as good news. Thus, even a decidedly average earnings season could prove to give equities a big boost.
As I suggested on Monday might be the case, the actual CPI data were not very interesting. However, the fact that such unexciting data produced such a significant response in the yield curve was. It hints at a bullish undertone to the market that could prove critical at a time when it seems that every piece of information is subjective and open to interpretation. That doesn’t mean that stocks are definitely going to be on the rise over the next few weeks, but it does make it look more likely now than it looked even yesterday.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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