CPI not falling in a tidy fashion

US equities were upended but closed relatively unchanged amid a choppy session following an as-expected US CPI for January. However, core goods were the critical driver of the strength, and with a rise in used car prices still to come, suggesting a few more substantial prints in the coming months should be expected, hinting that investors might be catching another case of inflation jitters.

But more problematic for stocks, especially of the long-duration variety, US10yr yields 6bps to 3.76% as the devil was in the details. Since yields are climbing on June rate hike bets, repricing a more hawkish Fed means market participants are becoming very skeptical that US inflation will fall in a tidy fashion.

But keep in mind this is a market that constantly asks different questions at different prices and on different days, and of course, there is no shortage of different answers.

Many business contracts typically reset in January, and companies traditionally set new prices, which are seldom fixed lower. January price inflation is also correlated with input cost inflation from the prior year -- which was substantial. And with macro inputs (strong jobs) pointing to higher inflation at the beginning of the year but inflation traders still pricing in a steep fall by year-end, will stock market operators and the Fed look through this sticky print? That is the big question.

In the meantime, until we get some decisive clarification from Chair Powell, traders might be more inclined to think the sticky CPI would look less like a one-off and more like part of a trend, which could have a more pronounced impact on the market's view of the terminal rates.

Fed's Barkin speaking after CPI: Report was "as expected as it can get," but "this inflation will be persistent." Fed's Logan: sees "gradual hikes" until there is a "convincing" inflation drop. Fed's Harker: "don't know yet" what Fed will do in March, Fed Funds to peak "above 5%", but how much above is "unclear."  

10-year US Treasury yields are up 7bps to 3.78% following a primarily in-line January CPI release this morning -- which is now causing some indigestion in equities. January core CPI rose 0.41% -- slightly above consensus and its recent trend -- as more significant than-normal beginning-of-the-year price hikes in several categories were set against downside surprises in used car prices and airfares.

Risk assets have spent recent weeks in a market-friendly environment characterized by improving prospects for an economic soft landing in the US, better growth news in Europe and China, and a Fed that continued to decelerate the pace of tightening. 

While in line, the CPI release is a reminder that lowering inflation towards the Fed's target may be more gradual than conventional thinking. And this environment may also result in a higher-for-longer rate environment -- somewhat counter to a market still pricing in a Fed funds rate cut later this year.

 Risks are consequently skewed to the upside to the market consensus 5-5.225 % terminal Fed funds rate target -- especially since the drag that we have been experiencing over the past 18 months from tighter monetary policy and the end of fiscal stimulus is set to diminish -- and may even flip to a tailwind once those rate impacts fade.

Since the February FOMC meeting, markets have digested three critical inputs:

We learned that the labour market is remarkably resilient to Fed tightening.

The Fed is making much less progress toward disinflation with the revision to the CPI data.

Financial conditions have failed to tighten enough for the Fed to have confidence that these first two trends will improve meaningfully in the coming months.

The Fed could likely live with easy financial conditions, provided inflation is falling decisively. Still, when you put a robust NFP, sticky inflation and easier financial conditions in the macro mixing bowl, it suggests 5-5.25 % is not nearly restrictive enough for the Fed to corral inflation to target.

Other assets

EURO bulls should be happy with EURUSD holding above 1.07. And now that the critical US data is out of the way, traders could return to Eurocentric positives where Nat gas prices continue to make new lows, reducing EU import bill, which means considerably less EURO selling is required to cover Europe’s energy bills alone.

Oil prices are getting weighted down by swelling US oil inventories after the American Petroleum Institute data showed a colossal 10.507 million barrels build last week.