A deeper correction or buy-the-dip?

Paid subscriber analysis

This week we got two new inflation prints, the consumer (CPI) and the producer (PPI) price indices. Both came in higher than expected. CPI was 0.4% in February, 3.2% annual (3.1% was expected), while PPI came in much hotter at 0.6% in February and 1.6% annual (1.1% was expected), suggesting a slight upward reversal in trend:

As we’ve been saying for a while now, inflation is sticky. It’s been sticky for 8 months, unable to go below 3% annual. Still the same trend we’ve had for most of last year: energy going down, food and other items going up. But overall, price levels are rising at 3% annually, which is not surprising given that economic growth is at 3-4%, and unemployment is below 4%. Looks like we’re getting some basic economic stylized facts back: high growth => low unemployment => higher inflation. The theory works! Also, wages are still growing at 4-5%, adding significantly to the stickiness of inflation. Once you renegotiate wages to go up, it’s very difficult to push them back down, absent a major economic shock to the labor market.

How did the markets react to this?

The first impact was that the probability of interest rate cuts got adjusted down. Remember how we started the year expecting that the Fed cuts 6 times and starts in March? Well, now it’s three cuts, and it’s more likely to start in July. We kept saying that 6 cuts this year are unrealistic amidst high growth, low unemployment and sticky inflation. Interest rates need to go down to stimulate economic growth. Cutting them too soon is a policy mistake, especially considering that the neutral rate of interest is higher than during the previous decade (we wrote about that here).

Ok, so the adjustment of rate cut probabilities should have led to a sell-off, right? Yes, to some extent. But be careful in interpreting the reasons behind the sell-off.