The inflation shocker
Yesterday’s US August CPI report shocked financial markets that had set themselves up for a lower than estimated inflation rate. One thing was the +0.1% m/m on the headline figure vs expected -0.1% m/m, which in itself was surprising given the lower input from energy prices, but it was the 0.6% m/m on the CPI core index that shocked the market. From food to shelter costs, it is clear that inflation has become broad-based and entrenched around 5-6% annualized rate as the 6-month average on the core CPI has hovered around 0.5% m/m for over a year now.
The reaction was brutal with S&P 500 futures plunging 5.4% from its intraday highs wiping almost the gains since 6 September. In Fed Funds futures the curve shifted 35 basis points lower for the April 2023 contract to 95.65 suggesting a peak US policy rate of 4.35%. Given the dynamics we are observing and the lack of elasticity in commodity markets our view is that there are upside risks to this market expectations and that the policy rate could reach as much as 5%. Inflationary pressures will continue to act as gravity on equities and the escape velocity cannot be reached before inflation is firmly lower and the Fed pivots on its policy.
The US 10-year yield has also responded to yesterday’s CPI report trading around the 3.44% level ahead of US trading hours zooming in on the previous peak of 3.5% from mid-June. Back then the S&P 500 futures traded around the 3,700 levels suggesting a 6.7% downside risks to US equities. Investors have to ask themselves what has really changed over the past three months to justify US equities so much higher at the same interest rate level? Revenue growth expectations have not moved that much, and expectations for operating margins should be lower given the signals we have got recently from companies in the consumer discretionary and industrials sectors.