Market Update – Reaction to Softer Inflation
Jun 14, 2024
Bottom Line at the Top Line
Markets reacted positively to this week’s Consumer Price Index (CPI) release. Softer inflation is good news for the Federal Reserve (Fed). Despite a good report this morning, the Fed will still likely communicate this afternoon their intentions to keep rates higher for longer in their updated Summary of Economic Projections. The updated dot plot will likely signal only two rate cuts this year, a change from the three cuts communicated back in March.
Key Points
- Consumer prices were unchanged in May after rising 0.3% in April.
- Bond yields dropped to their lowest levels this week (highlighted in the chart below) and stock futures rose after the release since it relieved some of the pressure the Fed had after the payroll report.
- The headline energy component fell 2% from a month ago, driven by a 3.6% decline in gas prices.
- Airfare, new car prices, and clothing were among the categories that decreased in May.
- Grocery prices were unchanged in May after falling in April, giving some reprieve to consumers, although price levels are still extremely high.
- Restaurant prices continue to rise as consumers have an insatiable appetite for going out to eat. Looking ahead, this category may be an important leading indicator for consumer sentiment amid a slowing economy.
Drivers of Inflation
Housing costs continue to be a challenge for consumers. Prices for shelter — which includes both rents and the imputed “owners equivalent rent” — rose 0.4% in May for the fourth consecutive month. However, industry data show rent prices are not increasing as fast as the official government data show. Industry data often include new leasing costs not initially captured by the Bureau of Labor Statistics, which explains why some of these industry measures show negative year-over-year rent costs since the middle of 2023.1
Rising vacancies should eventually suppress shelter costs, which is one of the stickier components of inflation.
Excluding food and energy, the annual rate of inflation decelerated to 3.4% in May from 3.6% the previous month.
Inflation Cools After a Rough Start to the Year
Source: LPL Research, Bureau of Labor Statistics, Bureau of Economic Analysis 06/12/24
Market Reactions
Thanks to Adam Turnquist, our Chief Technical Strategist, who created this second chart, we know some areas of the market often respond favorably to downside surprises in CPI. The bar chart highlights the average daily return of the S&P 500 and its sectors for all CPI release dates since the Fed started raising rates in March 2022. The returns are trifurcated between days when year-over-year (YoY) core CPI came in above, below, or in line with estimates.
Market Performance on CPI Release Dates (March 2022 — YTD)
Source: LPL Research, Bloomberg 06/12/24
Disclosures: Past performance is no guarantee of future results. All indexes are unmanaged and can’t be invested in directly.
Not all sectors respond the same way to downside surprises. For obvious reasons, the real estate sector often outperforms on these days, along with the technology and consumer discretionary sectors. Overall, the S&P 500 has historically climbed 1.8% on days when core CPI came in softer than expected.
Conclusion
Battling inflation is not just for central bankers. Fiscal and regulatory policy also have inflationary implications, along with demographic shifts. As noted in previous weeks, our economy is less interest rate sensitive, adding a challenge for effective monetary policy. In sum, the structural shifts in the economy could make some of the stickier components of inflation stick around for a while, which is one reason we think the Fed will keep rates higher for longer.
From an investment perspective, commodities could benefit from this period of sticky inflation, especially while we have supply and demand imbalances.
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IMPORTANT DISCLOSURES
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing. Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk. Indexes are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance of any investment and does not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results. This material was prepared by LPL Financial, LLC. All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy. Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. Asset Class Disclosures – International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets. Bonds are subject to market and interest rate risk if sold prior to maturity. Municipal bonds are subject and market and interest rate risk and potentially capital gains tax if sold prior to maturity. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply. Preferred stock dividends are paid at the discretion of the issuing company. Preferred stocks are subject to interest rate and credit risk. They may be subject to a call features. Alternative investments may not be suitable for all investors and involve special risks such as leveraging the investment, potential adverse market forces, regulatory changes and potentially illiquidity. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses. Mortgage backed securities are subject to credit, default, prepayment, extension, market and interest rate risk. High yield/junk bonds (grade BB or below) are below investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors. Precious metal investing involves greater fluctuation and potential for losses. The fast price swings of commodities will result in significant volatility in an investor's holdings. Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC. Not Insured by FDIC/NCUA or Any Other Government Agency | Not Bank/Credit Union Deposits or Obligations | Not Bank/Credit Union Guaranteed | May Lose Value
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