Rally Continues on CPI Report

Stocks opened higher today amid signs that inflation is falling (see below). The Dow is up 300 points and the S&P 500 is up .6%. Beat-down tech and communications sectors are up about 1%, and energy stocks are up 2% in early trading. Commodities and bonds are also broadly higher. With every passing day, it seems more and more like October 12th was the bear market low.

Inflation decelerated for the sixth straight month in December. As expected, the Consumer Price Index (CPI) fell .1% from November, and this could be the first hint of a new deflationary trend. Remember, there is a difference between price growth slowing vs. prices falling. On a year-over-year basis, price growth slowed to 6.5% from 7.1%. So-called Core CPI, which excludes food & energy and is thought to more accurately measure underlying inflation throughout the economy, slowed to 5.7% from 6.0%. Compared with a year ago, prices are actually lower for tech hardware, consumer electronics, used vehicles, gasoline, and clothing. On the other hand, prices for food, electricity, airfare, rent and medical care remain stubbornly high.

Of course, the Fed is also monitoring wage growth as a form of inflation. Today’s report showed that average hourly earnings growth slowed to an annual rate of 4.6% vs. 4.8% in the prior month. And because of a decrease in the number of hours worked, average weekly earnings growth is decelerating at a more rapid rate.

So on balance, these reports should give the Fed some leeway to slow the pace of monetary tightening. Investors generally expect only two more .25% interest rate hikes over the next few months. The bond market is telling us that rates will peak soon, then head lower as the full impact of Fed policy slows the economy and inflation. The Fed’s message is different, pledging to keep rates high for a sustained period until it judges inflation is on the way down to 2%. Tug-of-war between these two narratives will be the primary driver of market volatility over the next few months.