Inflation Heats Up but Markets Keep Rallying

We got the latest inflation data from the US this week, first the Consumer Price Index (CPI) on Wednesday and then the Producer Price Index (PPI) on Thursday.

Here’s the recap.

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Consumer prices

The latest CPI data came out on Wednesday and it came out hot. The year-over-year headline number rose to 3% in January from 2.9% in December. Economists had expected 2.9%.

Prices rose 0.5% on a monthly basis, also well above the 0.3% forecast.

Core CPI, which excludes food and energy prices, jumped from 3.1% to 3.3% from a year ago. It was up 0.4% on the month, compared with the estimate for 0.3%.

Shelter cost continued to be a problem. It rose 0.4% for the month and accounted for about 30% of the entire increase.

The most positive angle to these figures is that the core CPI has been unchanged at 3.3% for five straight months. So at least that part of the inflation story isn’t getting worse.

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Wholesale prices

On Thursday, we got the Producer Price Index (PPI) for January. At first glance, it looked like another negative surprise.

The headline inflation rate rose 0.4% on the month, higher than the 0.3% forecast. The annual rate came in at 3.5%.

Stripping out the more volatile categories, the monthly rate was in line with expectations at 0.3%. The annual rate was 3.4%, slightly lower than the readings in October, November, and December.

Looking below the surface, we did see some more promising signs. Physician care prices fell 0.5% on the month, domestic airlines declined 0.3%, while brokerage services dropped 2.2%.

Another noteworthy point in the report was that the December figure was revised up from 0.2% to 0.5%. I guess we should always take these numbers with a big grain of salt.

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The market impact

Higher inflation puts pressure on consumers and will hurt the economy if it doesn’t outgrow the inflation rate. What’s even more concerning to investors in the short term, however, is the fact that higher inflation may force the Federal Reserve to keep rates higher for longer.

The market reaction to these inflation prints was quite interesting.

• First up, the likelihood of rates remaining unchanged through 2025 jumped from around 20% to 30% on Wednesday but gave almost the entire move back on Thursday.
• US treasury yields rallied 2% on the expectation of higher rates after the CPI release with the 10-year going back above 4.6%. Also that move was reversed after the PPI print as the 10-year fell back to exactly where it was pre-CPI.
• The S&P 500 and Nasdaq Composite instantly fell around 1% when the CPI came out, more or less as you’d expect. However, they quickly started recovering and rose throughout the day Wednesday. The PPI was received positively as well, further boosting markets on Thursday. The Nasdaq finished the day 1.5% higher while the S&P 500 almost nudged a new record high.
• The dollar initially jumped 0.4% on the first inflation data but gave back the entire move in a few hours. The PPI reading sent it even lower, down more than 0.8% on Thursday.

To sum it up, the battle against inflation doesn’t seem to be over. Rate cuts seem less and less likely in the near future. And yet, investors look through it. Perhaps because 2.9% vs 3% on the headline CPI doesn’t make a difference anyway. Or perhaps because they’re looking ahead to the PCE, the Fed’s preferred inflation gauge which is now predicted to come in at 0.3% for January. That’s at least what I’ll be watching for next.