The December CPI Might Lead To Steeper Yield Curve

Inflation got here in hotter than anticipated in December, with the headline CPI rising by 3.4% vs. estimates for 3.2% and up from 3.1% in November. Additionally, core inflation rose by 3.9%, hotter than the estimates of three.8% however beneath final month’s 4.0%.

The inflation report, whereas holding just a few surprises, most likely means that inflation has fallen to a degree the place the Fed might lower charges to make sure that coverage would not develop into too tight however that inflation is sticky sufficient to maintain charges on the again of the yield curve elevated at or above present ranges. That is prone to result in additional yield curve steepening.

Sticky Inflation Stays A Drawback

The massive CPI shock that implies inflation is staying sticky is what’s happening beneath the floor with tremendous core inflation, which is definitely displaying indicators of accelerating during the last three and 6 months. The tremendous core CPI, which is CPI core companies much less housing, was 3.9% y/y in December, flat with November.

When digging into the index worth, the info reveals that during the last six months, tremendous core inflation has risen at an annualized fee of 4.54% and 4.3% during the last three months, significantly sooner than it has risen over the previous 12 months.

This may be a setback, particularly contemplating how a lot consideration the Fed has paid to this subset of inflation information over the previous two years. But it surely additionally might develop into an issue ought to items inflation come again sooner or later over the following few months.

Latest information reveals that transport charges have been rising, as famous by the WCI Composite Container Freight Benchmark Charge, which has soared by 122% over the previous six weeks.

Previously, we have now seen adjustments within the worth of this benchmark fee instantly tied to traits within the inflation of products, which could be seen by way of the CPI Commodities, excluding Meals and Vitality Commodities. One thing that can should be monitored intently ought to it persist.

Nonetheless Pricing In Charge Cuts

The bond market nonetheless sees one thing within the information that implies the Fed might want to lower charges aggressively in 2024 by as a lot as six instances and sees charges falling to round 3.9% by the top of 2024 versus the Fed’s median dot plot of 4.6%.

So, no less than up to now, the market is saying {that a} scorching December job report and a scorching December CPI report are usually not sufficient to vary its opinion on fee cuts. Additional including to the decision for fee cuts is the steepening of the yield curve, with the two-year fee falling by 4 bps to 4.32% whereas the 10-year fee stays flat.

With the two-year fee falling to the 10-year fee, it is the market’s approach of anticipating Fed fee cuts. That is inflicting the yield curve to steepen and transfer to -29 bps, which is sort of its highest degree since early November.

During the last two years, the yield curve has performed an essential half within the fairness market, with inventory costs for essentially the most buying and selling together with the yield curve inversion. The S&P 500 earnings yield, simply the inverse of the PE ratio, has intently tracked adjustments within the yield curve. They’ve, nevertheless, separated some because the center of December.

It is price noting that if the yield curve continues to steepen and normalize, it is fairly potential that this pattern for fairness costs to observe the yield curve resumes. It might even be why equities reversed earlier positive factors and turned damaging following the CPI report.

General, the CPI report means that the inflation fee is falling to a degree in keeping with fee cuts, however most likely not as many because the market has priced in. Moreover, the info is sticky sufficient to counsel that the again of the yield curve doesn’t fall any additional, and that most likely means extra yield curve steepening takes place.

Whether or not the connection between shares and yield continues to stay stays to be seen.