Another month has passed, but what changed?

Another month has passed, but we still find ourselves in a similar situation on the inflation front. On Wednesday, another disappointing report was released, as inflation continues to be more stubborn than most economists had expected. 

The news roiled equity and bond markets, with the small-cap Russell 2000 taking the brunt of the news, down almost -3% on the day of the release. Meanwhile, bond yields spiked, up over 20 basis points on the two-year treasury notes, as traders expect fewer rate cuts. But it wasn’t all doom and gloom, as PPI inflation showed a much more upbeat view. Let’s take a look at where things stand.

The Bureau of Labor and Statistics released the March CPI data on Wednesday, and the financial markets did not receive it well. The report showed the following:

Inflation table

Again, similar to last month, the numbers were not far from expectations, with each metric missing expectations by 1/10th of one percent. In normal times, this wouldn’t even show up on the radar. However, we are not in normal times when it comes to inflation, and we haven’t been for three years now, so every piece of information is scrutinized.

The main issue is that market participants are concerned that the inflation battle is stalling out. Headline inflation, sitting at 3.5%, has yet to make much progress in a year, where it now sits at the 12-month average. Meanwhile, Core CPI, which has made slow but steady moves lower over the last few years, increased for the first time since September 2022. This will undoubtedly give the inflation doves a bit of a scare.

However, it is not all bad news, and there still appears to be plenty of room for optimism. The chart below shows the primary items contributing to “excess” Core CPI. It intends to illustrate the categories pushing inflation up relative to their 2014-2019 (pre-COVID) trends. 

Excess Inflation

A few of the key takeaways that help show why we may be in a better position than the total numbers display include:

  • Core Goods and Autos, two primary inflation contributors in 2021/2022, have returned to normal levels.
  • Core Services excluding Housing & Auto Insurance, which was a concern in early 2023, has also returned to pre-COVID levels.
  • Housing and Auto Insurance are driving all of the excess inflation.
  • We have discussed housing at length, but all signs show this should diminish shortly.
  • Auto Insurance has recently contributed significant increases, but the lagged effect of higher car prices on insurance rates should be fully reflected later this year.

Finally, the Producer Price Index showed a more optimistic view of the inflation situation, with the MoM reading for headline and core both up 0.2%. Both were down from last month and in line with or better than expectations. This was a welcome relief as these numbers will eventually make their way into CPI. Even more importantly, it strongly signals that the Fed’s preferred inflation gauge, PCE, should continue to move in the right direction. 

In summary, while the news was not what anyone hoped for, it was not as dire as the market reaction would make it seem. There is still a reasonable path to the Fed’s year-end PCE target of 2.6%, which, based on their projections, should still result in a few rate cuts later this year.

Economy

  • It was a tough week across all financial markets on the heels of suboptimal inflation news. The S&P 500 was down -1.6%, the Nasdaq was down -0.5%, and the small-cap Russell 2000 was down -2.9%.
  • Preliminary estimates showed that the University of Michigan consumer sentiment for the U.S. fell to 77.9 in April from 79.4 last month (the highest level since July 2021). Figures came well below forecasts of 79, with both current conditions (79.3 vs 82.5) and expectations (77 vs 77.4) declining.
  • The number of people claiming unemployment benefits in the U.S. fell by 11K to 211K in the week ending April 6th, the lowest in one month, and below market expectations of 215K.

Stocks

  • U.S. equities were in negative territory. Financials and Materials led the decline, while Technology and Consumer Discretionary outperformed. Growth stocks led value stocks, and large caps beat small caps.
  • International equities closed lower for the week. Emerging markets fared better than developed markets.

Bonds

  • The 10-year Treasury bond yield increased 12 basis points to 4.50% during the week.
  • Global bond markets were in negative territory this week.
  • High-yield bonds led for the week, followed by government bonds and corporate bonds.