From 7 cuts to 2 cuts: the paths ahead
Paid subscriber analysis
Today we’ll talk about:
New inflation data and what it means (hint: inflation is sticky!)
Inflation composition (hint: housing is the driver, that might be the Fed’s fault)
The path ahead for markets according to institutional research (hint: bullish)
Seasonality in election years (hint: bullish)
We got a fresh batch of inflation data this week, for both CPI (came in higher than expected, 3.5% annual), and PPI (came in as expected) and the market reaction was quite strong: 2 big daily sell-offs on Wed and Fri, with an intermezzo of a rally on Thu - another volatile week, but with a negative trend. This is the second week in a row the markets are down, almost 3% from its all time highs two weeks ago. A clear break in trend, as we said last week:
“[The trend] got broken to the downside this week (already on Tuesday), and it failed to sustainably bounce back (especially after the sharp move down on Thursday).That’s a bearish sign. Friday was buy-the-dip once again (more like regression to the mean), but it didn’t push back above trend, which is a potential signal for a correction.”
But this time at least we know what caused it (we’re pretty sure): inflation coming in hotter than expected, and once again back to 3.5% annually. This makes it 12 months of inflation being stuck between 3 and 4%. That is a big sign that macro conditions were right and market sentiment wrong regarding the Fed cuts. As we said last time, inflation is still high (and well above the 2% target), unemployment is low, growth is strong => we get a no landing and rates stay high this year.
One interesting thing about inflation is its internal composition (see table below). Food and energy - two main components that used to drive inflation back in 2021 and 2022 - are down to 2.2% (food) and 2.1% (energy). So pretty much close to target. But all other items is where inflation is sticky - primarily, housing (5.7%) and transportation (10.7%).
Obviously, housing is the main driver here. Paradoxically, the reason behind this can easily be attributed to high interest rates. 30-year mortgage rates in the US are at 6.8%, which obviously adds pressure on rising housing prices. That would actually imply that cutting rates could exert negative pressure on housing prices, and therefore inflation in general. A bit of a stretch, but in these conditions, anything is possible.
From 7 cuts to 2 cuts
In light of this news, markets continued repricing rate cut probabilities. We are down to 2 cuts (first in July or even September, second in December).
Remember how we started the year? Markets were pricing in 7 cuts at one point after the December 2023 FOMC meeting. But we kept repeating that this was unrealistic and that the Fed would not cut so quickly unless there’s obvious fear of recession. And with the economy staying strong, and inflation picking up, there is less and less need for cuts. Higher for longer.