By Komson Silapachai, Partner, Research & Portfolio Strategy
Last week produced a flurry of inflation data points, and the bottom line is that inflation is moderating but we’re not out of the woods yet. The Fed is going to want to see inflation get closer to the target rate of 2%, so expect rates to hold steady through the first half of 2024. This is good news for fixed income investors; more on that here as well as here. The following is a recap of inflation data and how the market has priced recent news.
October’s inflation prints showed signs of cooling prices. Core CPI rose by only 0.23%, lower than the Street’s expectations of a 0.3% increase. The annual rate of core CPI now stands at 4.0%, down from 4.1% in September. Notably, auto-related categories experienced declining prices despite the recent auto strikes. Core services was softer across the board, with owners’ equivalent rent decelerating after a sharp increase in September. CPI including food and energy was unchanged in October and up 3.2% YoY. Producer prices also surprised to the downside, which added to the slowing inflation narrative.
Retail sales were not as bad as expected. Retail sales were not as bad as feared, falling 0.1% for the month versus Street forecasts of down -0.3%. Gasoline, auto sales, and building materials were the main negative contributors, while core retail sales grew by 0.2%. While the economy is showing signs of cooling, the pace has been slower than expected heading into the holidays.
Interest rates fell sharply in response to a downside surprise in US CPI data, and the yield curve shifted lower across the board. The 2Y treasury yield fell 16 basis points, while the 10Y treasury yield fell 21 basis points. Credit spreads compressed alongside the rally in risk assets, with IG corporate spreads tightening by 5 basis points to 1.17%. High yield spreads remained unchanged last week. The Barclays Aggregate Index turned positive on the year, with a +0.38% total return.
Rate cuts in early 2024? Coupled with the indication from the FOMC that the Fed could be done with hikes, the data above supports the notion that the last rate hike was in July 2023, and cuts could come sooner. Interest rate markets priced in a 35% probability of a rate cut in March 2024 and four rate cuts total next year. We see rate cuts in the first half of 2024 as unlikely, as inflation will probably remain above the target rate of 2% for much of next year. The cost of being “ahead of the curve” and cutting rates too early, risking a reacceleration in inflation, would outweigh the potential benefits. We believe the FOMC will tolerate weaker data for longer, which should result in rate cuts beginning later than the market expects.
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