TPLC - March CPI Report Is Bullish For Stocks And Bonds

2023-04-12 09:43:59 ET

Summary

• Inflation is falling as fast as it rose.
• The core rate is lagging in its decline due to categories that should abate as the rate of economic growth slows.
• The Fed is likely done raising short-term interest rates.
• Today's report is bullish for stocks and bonds.

Yesterday was a relatively quiet day for the major market averages in anticipation of this morning's inflation data, which investors expected to tip the scales either in favor or against a final interest rate increase of 25 basis points by the Fed. With disinflation well entrenched, economic growth starting to show meaningful signs of slowing, and last month's regional banking crisis weighing on financial conditions, I have been convinced that we are already at the terminal rate. Now that the headline number for the Consumer Price Index is already more than half way to the Fed's target of 2% from its peak of 9.2% last June, I think the consensus of investors will start to agree. This morning's inflation report should seal the deal.

Inflation eased for the ninth straight month with the headline Consumer Price Index falling from 6% in February to 5% in March. The monthly increase of just 0.1% was below the expectation for a 0.2% increase. The core rate, excluding food and energy, ticked up from 5.5% to 5.6%, as expected. The monthly increase for the core rate was 0.4%, which also was as expected. It took 18 months for the CPI to surge from 2% to more than 9% and over the past nine months it has fallen at a rate that has us on track to return to 2% in the same 18-month period.

The inflation hawks are convinced that our progress will stall as services inflation will remain sticky and keep the core rate of inflation elevated. In particular, they point to what are called non-housing core service items. As far as the core, the shelter index remains the most dominant factor in last month's increase, accounting for 60% of the increase and rising 8.2% on an annual basis. Yet we know a steep decline is in the pipeline for this item because of the decline in rents and rate of home price appreciation that is feeding into the annualized number each month. Hence the focus on non-housing items.

These include things like medical care and transportation services. Medical care costs have collapsed, declining in five of the past six months to an annual rate of just 1% in March. Transportation services, which account for approximately 25% of non-housing services, remain elevated at 13.8%. This was led by airline fares up 4%. I think this item has a lot to do with the excess savings built up by consumers who have been spending it on doing things over the past year rather than buying things. It should fade along with depleted savings as the rate of economic growth slows.

This is a bullish report. Regardless, I think the bearish consensus will try to spin it in the most negative light possible to defend the outlook for a recession and retest of the bear market lows later this year. Today's action in the stock and bond market appear to say otherwise.

Investors have been piling into the safe haven of higher interest bearing money market funds over the past month for obvious reasons. They can earn higher risk-adjusted returns with virtually no credit or duration risk, and avoid the volatility of the stock and bond markets. This looks like a sound strategy in the short term. The only problem I see is that the rate is variable, and if the Fed starts to reduce short-term rates during the second half of this year and into 2024, then money market rates will fall. At the same time, long-term yields should rise in anticipation of a rebound in the rate of economic growth. That could lead to losses on longer-durations bonds, which is the issue that crushed three now defunct regional banks this year.

I think this growing war chest of cash, which has now hit a record $5.2 trillion, could be the fuel that drives stocks higher later this year. All it will take is the headline that a new bull market is underway in the S&P 500 index. Stocks have no looked attractive since the lows of October last year, but once they are 20% more expensive they will have far greater appeal to the average investor. Fear will abate and greed will take over. That will probably be the best time to start reducing some risk again as 2024 approaches.

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