SPY - 10th Straight Month Of Improved CPI Core Rate Sticky VCSH A Hold

2023-05-10 09:38:11 ET

Summary

• Stocks rose and yields fell following the release of the April CPI report.
• Odds of a June 14 interest rate increase remain low.
• I see short-term corporate bonds as decently attractive, but the yield is not much higher than short-term money market rates.

The inflation narrative continues to be more positive.

The April CPI rate matched estimates at +0.4% while the Core rate also was up 0.4%. The year-on-year headline rate was +4.9% - continuing the downtrend since June last year and a tick better than economists’ forecasts. The Core rate on a year-on-year basis was up 5.5%, in line with expectations. The ex-food and energy rate remains sticky in the mid-5-percent range.

April CPI Report: Lower-Than-Expected Headline CPI YoY

Headline CPI Dropping Fast, Core Not So Much

According to the BLS , "The all-items index increased 4.9% for the 12 months ending April; this was the smallest 12-month increase since the period ending April 2021. The all items less food and energy index rose 5.5% over the last 12 months. The energy index decreased 5.1% for the 12 months ending April & the food index increased 7.7% over the last year."

April CPI Report Breakout

Equities rose in reaction to the report while rates were lower. The 10-year yield fell about five basis points and the 2-year Treasury rate also dropped back under 4%. The dollar was slightly higher premarket and gold prices were also modestly to the upside. Inflation is beginning to take a backseat to the growth outlook.

We are seeing smaller S&P 500 price moves on CPI Days and Treasury yields seem to be consolidating with the 2-year around 4% and the 10-year straddling 3.5%. I expect the ICE BofA Interest Rate Volatility Index ((MOVE)) to retreat from here – and that would likely be a bullish catalyst for both bonds and equities. If firms have more confidence in what their borrowing rates will be, then capital allocation decisions can be made with less trepidation.

Turning back to the CPI report, the big story was a weaker YoY headline rate, helping assuage investors’ fears that inflation was returning. Energy disinflation is an encouraging sign, but we still need to see core services ex-housing cool off further to give Fed Chief Powell more confidence about the inflation situation. Concerning news hit this morning with the Manheim Used Vehicle Value Index rising

Core CPI Hovers Near 5.5% YoY

In wake of the report, the Fed Funds futures market was not a whole lot changed – there remains just a modest chance of another quarter-point rate hike at the June 14 FOMC gathering.

Low Chance Of Another Rate Hike

In terms of price action, the S&P 500 has moved an average of +/-1.89% in either direction on the past 12 US CPI Days, according to Investing.com . You can see in the chart below from Bespoke Inves t that there have been more bullish than bearish reactions to CPI lately.

Generally Bullish CPI Day SPX Performances Recently

Given the 4.9% YoY Headline CPI rise, JPMorgan expects the S&P 500 to rise about 1% today.

Stock Market Scenarios Post-CPI

Following the CPI report, let’s home in on near-dated corporate bonds. According to the issuer , the Vanguard Short-Term Corporate Bond ETF ( VCSH ) seeks to provide current income with modest price fluctuation. The ETF invests primarily in high-quality (investment-grade) corporate bonds and maintains a dollar-weighted average maturity of one to five years.

VCSH Portfolio Characteristics

The fund has a low 0.04% annual expense ratio and sports a 5.1% weighted average maturity. Bond ETF investors should always look to the fund’s YTM for the best gauge of its true yield. With credit spreads not too high, not too low, and companies with ample cash on their balance sheets, I see that yield as of high quality.

Of course, investors can capture a 5% yield on money markets, but a comparable-duration Treasury fund has a yield closer to 4%, so you can earn a bit more with VCSH albeit with a hint of credit risk. In general, though, it appears investors are dipping back into bonds, and I like VCSH for a long-term play in this sub-asset class given its high liquidity and low cost.

The Technical Take

Notice in the chart below that VCSH has ended its downtrend that began in August of 2021. Shares are putting in a rounded bottom, and while I do not see massive price appreciation from here, the yield is plenty high enough to beat expected inflation over the coming five years – currently priced near 2.2%, according to breakevens .

Still, a move above the downtrend resistance line in the chart below would be bullish for short-term corporates. Overall, I’m a hold on VCSH as the downtrend appears to be broken while this product is ideal for investors seeking low-cost diversified exposure to the short-term corporate bond space.

VCSH: Downtrend Halted, Price Action Stabilizing

The Bottom Line

There were no big surprises in today’s CPI report, and the US economy remains on track to see lower inflation prints as 2023 progresses. April inflation will not alter the Fed’s plans much, and there remains a small chance of an additional rate hike.

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