Inflation fails to fall below 3%, disappointing economic forecasts


Wall Street got a reality check on Tuesday, with hotter-than-estimated inflation data triggering a slide in both stocks and bonds.

Equities moved away from their all-time highs after the core consumer price index topped estimates and climbed the most in eight months. Treasuries sold off, with two-year yields hitting the highest since before the December central bank “pivot.” Swap traders all but abandoned expectations for a Fed cut before July. And a measure of perceived risk in the US investment-grade corporate bond market soared — with three issuers getting sidelined.

The CPI data came as a disappointment for investors after a recent downdraft in price pressures that helped build expectations for rate cuts this year. The numbers also gave credence to the wait-and-see approach highlighted by Fed Chair Jerome Powell and a drumbeat of central bank speakers.

“If Powell and other Fed members hadn’t already thrown cold water on the prospects for a March rate cut a few weeks ago, today’s CPI report might have done that,” said Jason Pride at Glenmede. “Evidence of still-sticky services inflation is likely to give the Fed pause before cutting rates too quickly.”

Pride says rate cuts are likely still on the table for this year, but they may begin later than the market may be anticipating.

The S&P 500 fell below 5,000, heading for its worst CPI day since 2022. The tech-heavy Nasdaq 100 dropped as much as 2%, before paring losses. Microsoft Corp. and Inc. led declines in megacaps. US 10-year yields climbed 10 basis points to 4.27% — set for their highest since November. The dollar rose against all of its developed-market peers.

“While the door for a March cut had already been effectively shut given the recent Fed commentary and the jobs reports, the Fed has now locked the door and lost the key,” said Greg Wilensky at Janus Henderson Investors.

Swap contracts referencing Fed policy meetings — which as recently as mid-January fully priced in a rate cut in May and 175 basis points of easing by the end of the year — were roiled. The odds of a May cut dropped to about 36% from about 64% before the inflation data, with fewer than 100 basis points anticipated this year.

Fed officials are being proven right in their “take it slow” approach, according to Russell Price at Ameriprise. He says the first rate cut could come as early as June — but it could easily be July without a material improvement in near-term inflation trends.

The January CPI report is a reminder that inflation is a difficult, not-well-understood problem that doesn’t move in a straight line, according to Chris Zaccarelli at Independent Advisor Alliance.

“Bonds are too expensive if inflation is still a problem and the stock market can’t keep rallying if rates are going to be higher-for-longer – especially if the assumption that the Fed is completely done raising rates is incorrect,” he added.

Before Tuesday’s data, strategists at Citigroup Inc. noted that what was missing was traders hedging the risk of a very brief easing cycle followed by rate increases shortly thereafter. If inflation proves to be sticky, the debate about the Fed’s so-called neutral rate — which balances supply and demand — could resurface and spark the Treasury yield curve to steepen, they said.

To Jeffrey Roach at LPL Financial, while the data wasn’t exactly what the Fed wanted to see, investors will have to wait until later this month for a more comprehensive look at consumer prices.

“Just as the Fed said it wouldn’t rush to cut rates even after several months of encouraging economic data, they’re not going to immediately reverse course just because of one hotter-than-expected CPI reading,” said Chris Larkin at E*Trade from Morgan Stanley. “Until proven otherwise, the longer-term cooling inflation trend is still in place. The Fed had already made clear that rate cuts weren’t going to happen as soon as many people wanted them to. Today was simply a reminder of why they were inclined to wait.”

The disinflation process is not a straight line — and one hot print on its own after an extended string of more favorable releases does not represent a new trend, said Josh Jamner at ClearBridge Investments.

In fact, Fed policymakers favor an inflation metric known as the personal consumption expenditures price index, which is computed differently than CPI. The PCE has been trending much closer to the Fed’s 2% target.

The surprise jump in the January consumer price index probably will be less pronounced in the PCE — and potentially less alarming to central bank officials as they weigh when to cut interest rates, Morgan Stanley economists said in a note to clients.

More Comments on CPI:

  • Keith Buchanan at GLOBALT Investments:

“This report further delays anticipated rate cuts on the part of the Fed. Combined with last week’s nonfarm payrolls report, the labor market is still tight and inflation is still broad and above target, an environment that indicates the economy can withstand high for a little longer to make sure that inflation continues the path to the 2% target.”

  • Torsten Slok at Apollo Global Management:

“It is too early to declare victory over inflation. Maybe the last mile was indeed more difficult.”

  • Skyler Weinand at Regan Capital:

“Getting to the Fed’s magical 2% inflation target may prove more difficult than expected and result in elevated interest rates for a longer period of time.”

  • Rob Swanke at Commonwealth Financial Network:

“This is certainly not the news that the Fed will be looking for in order to begin cutting rates. So we may be on hold for several more months.”

“We remain aligned with the Fed’s comments of being more cautious in when to start cutting rates, and we believe the first rate cut will not come until the June or July meeting.”

  • Neil Birrell at Premier Miton Investors:

“We are not at the stage of worrying about inflation reaccelerating, but we are not out of the woods yet either.”

  • Quincy Krosby at LPL Financial:

“The ‘last mile’ - as expected - is proving to be stickier and more stubborn inhibiting even the most dovish wing of the FOMC.”

  • Bryce Doty at Sit Investment Associates:

“From the Fed’s perspective, economic growth is strong enough that there isn’t a sense of urgency on cutting rates. In the meantime, bond investors will get o enjoy higher yields a little while longer than many thought.”

  • Jim Baird at Plante Moran Financial Advisors:

“There’s still a viable path to a soft landing, but the January inflation report is a reminder that getting there won’t be a walk in the park. Deviating too far off the optimal policy path could lead to one of two undesirable outcomes. A resurgence in inflation is a risk, but isn’t the only one; the potential for a policy-induced recession – even if mild – still can’t be dismissed.”

  • Alexandra Wilson-Elizondo at Goldman Sachs Asset Management:

“A delayed Fed means a focus on cash rich companies that benefit from higher real wages and a strong consumer, rather than on cyclicals that have indebtedness in floating rate form. For rates, we have kept dry powder for better entry points into the market as it reprices the central bank delay and valuations are more appealing with better risk/reward.”

Bank of America Corp. clients posted the largest outflows from US equities in five weeks in the period ended last Friday, also logging the largest exit from individual stocks in seven months.

Clients were net sellers of US equities last week, withdrawing $1.9 billion from the asset class — the most in five weeks, BofA quantitative strategists led by Jill Carey Hall said in a note Tuesday.

Investors are going “all in” on US technology stocks as they turn the most optimistic about global growth in two years, according to a separate survey by BofA.

Allocation to tech is now at the highest since August 2020. Exposure to US equities more broadly has also risen, while easing macro risks prompted investors to trim cash levels by 55 basis points from January. Previous such declines in cash levels were followed by stock market gains of about 4% in the following three months, strategist Michael Hartnett wrote in a note.

US equity futures had a sharp turn to bullish flows in the middle of last week, ending it with $18 billion new longs in S&P 500 futures, according to Citigroup Inc. strategists.

Nasdaq 100 futures also had $7.4 billion new longs, and long positioning on the benchmark is very extended and completely one-sided, a team led by Chris Montagu wrote.

Source: Bloomberg

Corporate Highlights:

  • Coca-Cola Co. gave a 2024 organic revenue outlook that beat expectations, with a diverse group of products expected to boost results.
  • GlobalFoundries Inc., the largest US maker of made-to-order semiconductors, gave a lackluster revenue forecast for the current quarter, indicating that a glut in industrial and automotive components is still weighing on orders.
  • AutoNation Inc., one of the biggest car dealership chains in the US, beat analysts’ fourth-quarter profit and sales expectations.
  • Marriott International Inc. reported fourth-quarter earnings that topped estimates as the company benefited from demand growth outside the US.
  • Biogen Inc. reported fourth-quarter revenue that missed analysts’ expectations as the company’s multiple sclerosis drugs continued to decline.
  • Shopify Inc. reported sales and profit for the fourth quarter that narrowly beat analysts’ estimates, suggesting the Canadian e-commerce giant fended off competition from Asian shopping platforms like Temu, Shein, and TikTok.
  • Activist investor Carl Icahn disclosed a 9.91% stake in JetBlue Airways Corp., calling the stock undervalued, and said he’s had talks with management about the possibility of representation on the board.
  • ASML Holding NV dropped in the first minutes of trading before quickly recovering, with traders blaming the unexpected slump on an erroneous trade.

 (Reuters) - U.S. consumer prices increased more than expected in January amid rises in the costs of shelter and healthcare, but the pick-up in inflation likely does not change expectations that the Federal Reserve will start cutting interest rates in the first half of this year.

The consumer price index (CPI) increased 0.3% last month after gaining 0.2% in December, the Labor Department's Bureau of Labor Statistics said on Tuesday. Annual revisions to the CPI data published last Friday were mixed but generally showed inflation was on a downward trend after surging in 2022.

In the 12 months through January, the CPI increased 3.1%. That followed a 3.4% advance in December. Economists polled by Reuters had forecast the CPI gaining 0.2% on the month and rising 2.9% year-on-year. The annual increase in consumer prices has moderated from a peak of 9.1% in June 2022.
The BLS updated the seasonal factors, the model it uses to strip out seasonal fluctuations from the data. New weights, which saw the housing share rising and that of new and used cars lowered, were used to calculate the January CPI data.
That could partly explain the stronger-than-expected readings, which economists said were likely temporary.
Financial markets anticipate that the U.S. central bank will start cutting interest rates in May, though some economists are gravitating towards June, given the still tight labor market and persistently elevated services inflation. Policymakers have said they are in no hurry to start lowering borrowing costs and want convincing evidence that inflation is on a sustained slow path.
While significant progress has been made, risks remain, including the potential for renewed supply chain problems due to Red Sea shipping disruptions and drought in the Panama Canal. The inflation outlook, however, remains fairly favorable as the increase in rents is expected to moderate this year.
Since March 2022, the Fed has raised its policy rate by 525 basis points to the current 5.25% to 5.50% range.
Excluding the volatile food and energy components, the CPI rose 0.4% last month after increasing 0.3% in December. In addition to rents, beginning of the year price increases also likely accounted for the rise in the so-called core CPI.
The core CPI advanced 3.9% year-on-year in January, matching December's increase.
Though consumer prices remain elevated, measures tracked by the U.S. central bank for its 2% inflation target have improved considerably. The increase in the personal consumption expenditures (PCE) price index slowed to an annualized rate of 1.7% in the fourth quarter from a 2.6% pace in the July-September quarter. The core PCE price index rose at a 2.0% rate, unchanged from the third quarter.

The hot January consumer price inflation data is a setback for the Federal Reserve, but it is "entirely unwarranted" to jump to the conclusion that domestic inflation is heating up again and the Fed might have to profoundly revise its rate cut plan based on one report, said Krishna Guha, former top staffer at the New York Fed and now vice chairman of Evercore ISI.

The Fed will be "uncomfortable" and "more firmly committed to patience," Guha said, in a note to clients.

The Fed has penciled in three rate cuts for this year.

The central bank will wait until June before cutting interest rates to confirm that inflation is moving back durably to the 2% target, he said.

 In January, President Biden continued to emphasize his stance on inflation, noting that the annual rate of price growth in the economy is gradually decreasing, aligning it with more historically typical levels. Notably, wages are growing at a faster pace than prices, which is a positive development for workers. President Biden highlighted this by stating that the current wage growth represents the strongest seen in any economic recovery over the last 50 years.

However, the President also acknowledged that the report revealed challenges for consumers. Despite robust growth and employment, inflation, while declining by two-thirds from its peak, still requires further measures to lower costs. The report revealed concerning trends in two crucial categories: housing and food. Grocery and restaurant meal prices experienced accelerated growth in January compared to the previous year's end. Additionally, shelter costs, encompassing rents, continued to rise significantly.

The White House officials were specifically troubled by this data, considering the impact on both the political and economic landscape, particularly in an election year. They would have preferred to witness a slowdown in price growth or even a decrease in prices for renters and shoppers. However, due to the prevailing trends, the officials recognized limitations in effecting immediate change. Consequently, President Biden is using his platform to address this issue, specifically by calling out grocery chains and major food companies on their profit margins and urging them to take further action to reduce prices for consumers.

President Biden emphasized his dedication to alleviating costs for middle-class families, including addressing the prices of insulin and other prescription drugs, combating hidden fees, and demanding that corporations pass savings on to consumers instead of masking price increases by reducing product sizes. Republicans, however, seized the report to criticize President Biden's efforts to contain inflation, indicating their belief that his strategies are not effectively addressing the issue.  

More Americans will be thinking twice before they say yes to a fancy dinner out on the town.

The cost of dining out in January was up 5.1% year over year and up 0.5% compared to the previous month, according to the latest inflation data from the Bureau of Labor Statistics. On the other hand, the cost of groceries moderated, with a 1.2% increase compared to last year and a 0.4% increase compared to December.

"Historically, when commodity inflation runs ahead of labor inflation, grocery pricing pushes ahead of restaurants," Citi analyst Jon Tower wrote in a client note. "When labor inflation runs ahead of commodity inflation, restaurant prices tend to outpace grocery pricing."

Labor is a key pressure point this year, as 22 states raised their minimum wages on Jan.1, and Oregon, Nevada, and Florida are set to increase theirs later this year.

And California faces a looming wage jump as a result of a new fast food industry law. Beginning in April, food chains that have at least 60 locations nationwide will be required to raise their minimum wage for restaurant employees to $20 per hour.

As the bill rises, some customers will likely pull back on restaurant visits in favor of cooking at home. "You're going to see greater pivot at that lower income level," Tower told Yahoo Finance over the phone.

This is already putting pressure on brands like McDonald's (MCD). In its third-quarter earnings call last week, CEO Chris Kempczinski called it a "battleground" to get the attention of the low-income consumer.

"There's some transaction size reduction" and "some trade down" among the demographic, he said.

Others with higher exposure to low-income consumers include Wendy's (WEN), Domino's (DPZ), and Taco Bell (YUM), per Citi's analysis.

Chili's parent company Brinker International (EAT) has also been trying to adjust to changing consumer sentiments. "We're seeing improved responsiveness to TV ads that showcase really sharp value," CEO Kevin Hochman said in a call with investors.

But customers who come in for deals aren't "buying as much alcohol or desserts," he said. The company is planning to use promotions like $6 margaritas to boost traffic.

More discounts could be coming. If foot traffic broadly "does not improve from this point forward," companies will have to offer better deals, said Tower, or lean into categories that may not be as inflationary, like fries or chicken over beef.

While Starbucks (SBUX) tends to skew toward a higher-income demographic, some of its customer base is changing their spending habits as well. The coffee chain's US foot traffic was up a mere 1% in its latest quarter, while the check size went up 4%.

Both numbers were under analysts' estimates, partially because the "occasional" customer visited less.

Starbucks drinkers are "managing their checks, managing their frequency, or doing a combination of both," said Tower.

NEW YORK, NEW YORK - JANUARY 30: People exit a Starbucks store in Manhattan on January 30, 2024 in New York City. The global coffee chain officially introduced its extra virgin olive oil-infused drinks on Tuesday. Named Oleato, the drinks debuted in Italy in February 2023 and arrive in stores on the same day Starbucks will report fourth-quarter earnings. (Photo by Spencer Platt/Getty Images)
People exit a Starbucks store in Manhattan on January 30, 2024, in New York City. (Photo by Spencer Platt/Getty Images) (Spencer Platt via Getty Images)

But consumer staples companies that supply grocery stores, restaurants, and bars could be well positioned in 2024.

PepsiCo (PEP) CEO Ramon Luis Laguarta said on an investor call that the company is "putting a lot of focus" on the food away from home channel as people continue to go back to normal socializing patterns. The company is expecting to gain market share within the restaurant industry, per Laguarta.

How much people continue to go out will be the issue to watch for food companies that have large "away from home" businesses, Bank of America analyst Bryan Spillane told Yahoo Finance Live.

But moderating inflation likely won't result in lower prices in grocery aisles, said Spillane. Rather, consumer staples companies will hold the higher prices and reinvest the profit behind their brands.


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