Is the 'January Exceptional Case' still valid? The outcome of the U.S. February CPI will be revealed tonight.

Wallstreetcn
2024.03.12 10:03
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HSBC believes that the "January exception theory" is not enough to explain the upward trend in inflation. The inflation in the service industry has been on the rise for quite some time, and this week's CPI data may once again disrupt the market.

The next steps for the US stock market? When will the Fed start cutting interest rates? Tonight's inflation data performance is particularly crucial.

At 20:30 on Tuesday Beijing time, the US Department of Labor will release the CPI data for February. The market generally believes that overall inflation will accelerate on a MoM basis, while core inflation will cool slightly. Major investment banks have relatively small differences in their forecasts for February CPI, with the highest core CPI forecast at 0.4% and the lowest at 0.2%.

Overall inflation CPI YoY remains flat at 3.1% from the previous month; MoM is expected to accelerate to 0.4%, up from 0.3%, potentially reaching a new high since August last year.

Core CPI is expected to decrease from 3.9% to 3.7%, marking the smallest YoY increase since May 2021; MoM is projected at 0.3%, a further slowdown from the previous 0.4%.

The current US CPI has become a key data point influencing the US stock market. In the previous month, January CPI exceeded expectations across the board, leading to the complete abandonment of rate cut hopes in March. On that day, the SPDR S&P 500 recorded the largest CPI release day decline in over a year, leaving investors with lingering fears, and the market is now on edge.

Analysts believe that the January CPI exceeding expectations was just a seasonal exception, and the downward trend in inflation is expected to continue. However, the "last mile" of inflation resistance is proving more challenging than imagined, and this data will likely prompt the Fed to remain cautious. Nevertheless, HSBC believes that the "January exception theory" is insufficient to explain the upward trend in inflation, as service sector inflation has been on the rise for quite some time, and this week's CPI data may once again disrupt the market.

MoM Acceleration in February CPI, Slight Cooling in Core CPI

Energy inflation is reversing and accelerating, while core service inflation remains stubborn, making the "last mile" of inflation resistance more challenging than expected.

Looking at various components, energy prices have been a significant driver of the overall CPI increase, while deflation is expected to continue in areas such as automobiles and food. In terms of core service inflation, housing inflation is expected to slow down, with the growth rate of owner's equivalent rent (OER) falling, and hotel and airfare prices moderating after a sharp increase in January.

  1. In February, MoM CPI is expected to further rise to 0.4%, with the surge in oil prices adding to the woes. According to data from the American Automobile Association, regular gasoline prices have risen by about 20 cents from a month ago, an increase of over 6%. Wells Fargo Bank predicts that energy service prices will rebound by 4% in February, driving up gasoline prices.
  • Excluding food and energy, core inflation continues to contract, especially with the negative growth in the prices of used cars. Goldman Sachs predicts a 0.4% decrease in used car prices and a 0.3% decrease in new car prices, reflecting lower auction prices and significant promotional incentives from dealers.

  • The key housing inflation growth rate will slow down. Following a surge in OER in January, OER in February will drop to 0.47%. However, the main residence rental increase, after a slight slowdown last month, will slightly rise to 0.42%.

  • The growth rate of non-rent core services (super core CPI) will slightly decrease, from a MoM increase of 0.848% in January to 0.579%. Hotel and airfare prices will peak and fall, while car insurance prices will slightly accelerate, and medical healthcare service inflation will rise.

Looking ahead, it is difficult for core CPI to return to the 2% target in the short term. Fidelity has raised its annual inflation expectations, expecting core CPI to grow at a rate of 3.3%. Goldman Sachs predicts that in December 2024, the YoY core CPI will be 2.9%. The New York Fed's one-year inflation expectation survey remains at 3%, while the Atlanta Fed's "sticky prices" inflation, based on a 12-month period in January, remains at 4.6%, focusing on housing and insurance projects.

Verifying the Validity of the "January Exception" Theory

Scott Anderson, Chief U.S. Economist at BMO Capital Markets, stated that the economy may encounter some bumps on the road to the Fed's inflation target. Fidelity Bank also mentioned that despite data showing persistently high inflation, the overall underlying trend has not strengthened.

HSBC believes that the "January Exception" factor is not enough to explain the upward trend in inflation. The inflation in the service industry has been on the rise for quite some time. This week's CPI data may disrupt the market again, especially with the recent trend of sovereign bonds outperforming stocks. However, this will not affect the long-term performance of U.S. stocks, as only a significant increase in U.S. bond yields could potentially dampen market enthusiasm for stocks.

Even if inflation rebounds, HSBC believes that major central banks will eventually cut interest rates. What truly matters is when central banks will start cutting rates and by how much:

  • For overall risk assets, whether the Federal Reserve, the European Central Bank, or other major central banks start cutting rates in May or June, or later, is not crucial. Whether they cut rates twice, three times, four times this year, or even more, does not make a significant difference. As long as the long-term interest rate expectations do not return to the danger zone shown in the chart, we believe that any decline in risk assets will be temporary and will present buying opportunities after the drop. Conversely, if the inflation rates of major global economies decline again in the coming months, or even decline faster, it may reduce interest rate volatility and lead to another round of comprehensive rebound.

Will the Fed Take a "Soothing Pill" or Be "More Cautious"?

Analysis suggests that despite a significant decline in inflation since the middle of last year, the latest data may show that even excluding the impact of rising oil prices, price pressures are still more stubborn than expected by Fed officials. The latest data may strengthen the Fed's determination to keep interest rates unchanged at the policy meeting in late March, and may even extend into the summer.

Fed Chairman Powell reiterated in congressional testimony that although inflation will continue to slow, the central bank is currently unable to be certain that the inflation rate has approached the target level of 2%. He added that as long as inflation continues to slow, "rate cuts can and will" begin this year.

Analysts at Wells Fargo Bank pointed out:

The data for February may reinforce this narrative, as the annualized growth rate of core CPI at the end of February may remain at 3.9% over the past three months, the Fed may need more confidence to be sure that inflation is steadily returning to the target.

Morgan Stanley emphasized:

They anticipate that the strong inflation rate in the first quarter of 2024 will be one of the factors supporting the postponement of rate cuts until June, indicating that there are still challenges ahead.

UBS believes:

Despite the recent significant slowdown in inflation, the FOMC is not eager to relax its tightening monetary policy stance unless inflation continues to decelerate.

According to the FedWatch tool from IQ Option, traders expect 3 to 4 rate cuts this year, with a probability of nearly 60% for a 25 basis point rate cut in June.

Market on Edge

After the unexpected CPI data in January was released, the market responded with a bleak performance. This disaster left Wall Street with lingering fears, as the market is concerned that the upcoming CPI data for February may cause greater volatility in US stocks.

In a report on Monday local time, Citigroup stated that a strategy known as a parity portfolio indicates that the SPDR S&P 500 index may fluctuate by 0.9% on Tuesday, the largest expected volatility since April 2023 before the CPI announcement. The reaction of the SPDR S&P 500 to tonight's CPI may be more intense than its reaction to next week's Fed interest rate decision. Below are Goldman Sachs' predictions on market reactions under different core CPI data: