SHY - January CPI Near Expectations Treasuries Waver STIP No Longer A Hot Play

Summary

• The January CPI report revealed inflation data that was not far from market expectations.
• Stock futures straddled the unchanged line, as past CPI-date volatility has not yet played out so far today.
• I see balanced risks with short-term TIPS, and would rather keep things simple with short-term money with nominal short-dated Treasuries.

The January CPI report was close to what investors expected at +0.5% on the headline figure month-on-month. The core rate was up 0.4% - also as expected.

On a year-on-year basis, the headline rate was 6.4% which follows last month's 6.5% - the fourth straight monthly drop. The 5.6% yearly core rate was lower than the 5.7% reported for December. Both the YoY headline rate and core figures were slightly higher than economists' expectations, however. Still, it was the seventh consecutive monthly decline in the CPI since it peaked in July of last year.

Interestingly, used car prices were down 1.9% for the month, but shelter prices were up by a strong 7.9% from a year ago. Of course, real-time housing price data from outlets like Zillow show weak housing price trends. Most important perhaps is the core services ex-shelter gauge, which remains stubbornly high - up 0.3% in January.

January CPI Report Details

Meanwhile, US real average hourly earnings were -1.8%, cooler than the -1.7% from the prior month while weekly earnings were 1.5%, hotter than the -3.1% December figure.

Overall, the report was not too far from expectations, despite the warm year-on-year figures. Services inflation continues to be driven by wages and housing while goods deflation persists. In the moments after the report, equity future drifted around the unchanged line while the dollar was slightly lower. Treasury yields wavered but were modestly in the red compared to earlier in the morning.

This could be the third straight tame CPI Day for the S&P 500. Notice in the chart below that the SPX moved big from August through November, but the reports released in mid-December and a month ago were tame. Perhaps the market has a handle on where inflation is headed.

S&P 500 Performance On CPI Day Since January 2022

But what about the Fed? The FOMC wants to ensure consumer increases improve. With some strong labor market data lately, the Fed Funds forward curve shows a higher terminal rate - now near 5.2%, up from under 4.9% at times last month.

Maybe more importantly, the "higher for longer" narrative is gaining stream, with the year-end Fed rate seen just shy of 5%. All the while, the 6-month T-Bill yields that very same amount, near its cycle highs. As inflation trends improve, the TIPS market may be less attractive. Let's take a look at one short-term TIPS ETF and its relative performance.

Fed Rate Seen Higher For Longer Amid Strong Economic Data

According to the issuer , the iShares 0-5 Year TIPS Bond ETF ( STIP ) seeks to track the investment results of an index composed of inflation-protected US Treasury bonds with remaining maturities of less than five years. It's an effective way to play trends in low-risk TIPS since the duration is so small. What I also like about STIP is that it features just a 0.03% annual expense ratio and trades with a tight spread of just one basis point.

STIP Portfolio

Notice in the chat below that STIP outperformed off the March 2020 low as inflation expectations increased all the way through early last year. Since Q2 2022, though, it has underperformed the iShares 1-3 Year Treasury Bond ETF ( SHY ) as inflation, while high, has not surprised to the upside as much. I see that trend continuing, so sticking with SHY or even a money market for short-term cash needs is appropriate in my view.

STIP: Relative Performance Is Sideways Vs SHY Lately

The Bottom Line

I would stick with nominal Treasuries right now over TIPS. Both have provided a solid total return since October, but I see the major upside surprises in inflation as being over with, so TIPS on a short-term basis are not as attractive. Going with something like SHY should suffice.

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