This morning, CPI data revealed the highest annual headline and core inflation rates for decades, something which traders and investors have been reportedly afraid of for several months. The obvious surface take on that is that the continued rise in prices makes it look extremely unlikely that all this will really turn out to be transitory, as Fed Chair Jerome Powell was so fond of saying until recently. That would make rate hikes more likely to come and likely to come sooner than currently anticipated. And yet, immediately following these numbers, all three major stock indices jumped:
S&P 500 Futures (ES) 1 Minute Candles
Clearly, there is something other than just the raw data that is driving the reaction. In fact, there are a couple of things.
The first is that while the numbers were "bad," for want of a better word, and certainly worse than officially expected, they could be categorized as "not as bad as they could have been." As I have said before, that is a terrible reason for a rally in anything, but it often happens. Markets look forward and tend to price in extreme scenarios, so while "not as bad as it could have been" is still bad, it is good when "really bad" is priced into a market.
The second is that while the annual inflation rate of 6.2% was the highest for around thirty years, the breakdown of the data makes it pretty clear what the primary contributing factors are. Energy accounted for a large part of that increase, for example, with food, and new and used cars, also major contributors. On the other hand, things like medical services and other non-energy services, while still showing increases, were moderating factors in the overall inflation rate.
To many people, that may sound like a distinction without a difference. If the overall cost of living is going up, it really doesn’t matter to consumers what's rising faster or slower. However, in terms of future impact, where price increases are concentrated is extremely important. When, as is the case currently, those increases are mainly in commodity-heavy parts of the economy like autos, food, and energy, it is good news.
Commodities are volatile in nature, and the massive disruption wrought by a complete shutdown of the global economy and a sudden re-opening has increased that volatility. Volatility, however, is a two-way phenomenon, and the recent big moves have been downward. Crude oil, for example, stayed elevated for most of November, the month covered by these data, but fell over 25% in the last week of the month. That suggests that the December numbers overall will be better.
The relatively slow price increases outside of commodity driven parts of the economy also suggest that wage pressure, the primary driver of the kind of cyclical inflation that really troubles central bankers, is not as great as feared. Much has been made of a few isolated incidents such as the recent unionization at a Starbucks in Buffalo, but these numbers indicate that overall, the much-publicized labor shortage is not causing wages to spiral out of control.
Commodity prices fall as easily as they rise, but that isn’t the case with wages, so this data set implies that "transitory" may actually describe current inflation quite well, even if Powell won't be using that word anymore.
If we add together commodity, rather than wage-driven, inflation and the effects of market positioning, a jump in stock prices on what looked initially like a worrying CPI report makes perfect sense. What remains to be seen is whether overall wage increases remain relatively muted, whether commodity prices really have turned the corner, and, most importantly, whether Powell will have the courage to revert to his transitory view if those things turn out to be true. We aren’t out of the woods yet, but this report reduces the danger of a big drop as the year ends, so the jump in stocks is not as strange as it seems.
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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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