Today’s market narrative appears to be taking a new turn. Just last year, everyone was focused on celebrating the economy’s so-called “soft landing” from 40-year-high inflation. But now, things seem to be changing. Just last Friday, we saw a massive “good news is bad news” day in U.S. equity markets.
On Friday, January 10, the U.S. Bureau of Labor Statistics released its December jobs report. The U.S. economy added 256,000 jobs—roughly 100,000 more than mainstream economists anticipated. Not only that, the unemployment rate fell from 4.2% in November to 4.1%. Around the same time, a closely watched measure of inflation expectations produced a concerning signal.
Preliminary data from the University of Michigan’s monthly survey of consumers showed that people across various demographics are now bracing for a faster pace of inflation.
So, the emerging narrative was high (or higher) inflation amid a surprisingly resilient economy. In that same University of Michigan survey, year-ahead inflation expectations jumped from 2.8% to 3.3%, while the longer-term outlook (five- to 10-year) rose from 3.0% to 3.3%. That’s a notable shift for a single month and one of the largest since COVID-19.
Until recently, Federal Reserve officials pointed to “well-anchored” inflation expectations as the reason they felt confident cutting interest rates in the second half of 2024. This, in tandem with a weakening summer jobs market and falling inflation numbers, allowed the Fed to inch its lending rate closer to what it calls “neutral.” But over the past few months, slight signs of an inflation resurgence—combined with a robust labor market following the Fed’s 100-basis-point cuts—have reshuffled the economic landscape. And that’s without factoring in any potential economic ramifications of President-elect Donald Trump’s second term.
As a result, the buzz around additional rate cuts in 2025—i.e., more economic “juice”—is losing steam. Some analysts, including those at Bank of America, now predict that no further cuts will materialize this year. Talk of potential rate hikes has even crept in. Somewhat unexpectedly, a stronger economy could be bad news for stocks if it means more inflation pressure and the possibility of a tighter Fed policy. In other words, good news might be bad again.
Just four months ago, the Fed was signaling four more rate cuts in 2025, summing to another 100 basis points. Last month, it was suggested that the number might be half as large. Now, the Fed might be done cutting rates altogether. Fed Governor Michelle Bowman has led the charge by publicly stating that December’s rate cut should be the last of this cycle, citing “upside risks” to inflation.
But, shift forward less than a week and the market exuberance over two sets of inflation numbers seems to have swung the pendulum back in the other direction. This past week, we received updated PPI and CPI numbers, which were better than expected. And Core CPI—a subset of the more critical reading—was a whopping 0.1% better than expected (yes, that’s sarcasm). And it was that slight variance from expectations that, at least temporarily, gave markets a counterpoint to the prior week’s narrative.
But will it be enough? The big question is whether the new data is just a blip or a continuation of the overall disinflation trend. Is the “high(er) inflation again” storyline overblown or only beginning? We simply don’t know yet. What we do know is that more market participants are reacting swiftly to even the slightest variance in expectations, which will likely make for a more volatile year in financial markets.
Markets / Economy
- Marginally better inflation numbers provided some positive momentum to the markets. The S&P was up 2.9%, the Nasdaq was up 2.4%, and the small-cap Russell 2000 was up 4.0%.
- Core CPI rose by 0.2% from the previous month, slowing from 0.3% in November and undershooting market expectations that they would increase by 0.3%.
- Headline CPI increased 0.4% MoM in December, the most since March, compared to 0.3% in November and forecasts of 0.3%. The index for energy rose 2.6%, accounting for over 40% of the monthly increase.
- Core PPI was unchanged from the previous month, halting the 0.2% increase in November and contrasting with market expectations that it would accelerate to a 0.3% increase.
- U.S. Retail sales increased 0.4% MoM in December, the least in four months, compared to an upwardly revised 0.8% rise in November and below forecasts of 0.6%.
Stocks
- U.S. equities were in positive territory. Energy and Financials were the top performers, while Healthcare and Consumer Staples lagged. Value stocks led growth stocks, and small caps beat large caps.
- International equities closed higher for the week. Emerging markets fared better than developed markets.
Bonds
- The 10-year Treasury bond yield decreased 17 basis points to 4.61% during the week.
- Global bond markets were in positive territory this week.
- High-yield bonds led for the week, followed by corporate bonds and government bonds.
