For the first time in a long time, stock and bond markets are flashing divergent signals on the economy and future Federal Reserve policy. Tuesday’s inflation report will go a long way in determining which one is right.
After the Fed’s campaign to combat the hottest inflation in decades battered stocks and bonds alike in 2022, both markets rallied to start this year as optimism grew that the central bank is nearing the end of its tightening campaign.
That twin rally has stumbled in recent weeks. While Treasury yields are still lower than at the end of 2022, two-year yields last week posted their biggest weekly rise since early November and continued to climb on Monday. While the S&P 500 slipped 1.1% last week, it wiped out those losses Monday, re-establishing 2023’s nearly 8% advance.
The rethink was spurred by January’s blockbuster employment report, which showed that the US economy added nearly double the number of jobs forecast. As a result, swaps traders now see the Fed’s policy rate peaking at about 5.2% in July, versus about 4.9% earlier this year. The repricing is more in line with the median projection of Fed officials at just above 5.1%.
Economists polled by Bloomberg expect consumer price growth to fall to an annual rate of 6.2% in January, down from 6.5% the prior month. The month-over-month reading is expected to rise 0.5% after falling by 0.1% at the last reading.
Yet a team of researchers at Deutsche Bank says that while core inflation has been falling since June, the pace has been less extreme than many might realize. They also note that some components, such as used car prices, have risen this year.
“The CPI is going to be a test of who’s got it right — the bond market or the stock market,” Art Hogan, chief market strategist at B. Riley, said by phone. “Right now, the anticipatory move in bond yields likely is right because the consensus is higher month over month on the CPI. Full stop. But the post-CPI-print reaction is where the test results come in.”
The S&P 500 has over the past two months been reacting less negatively on CPI-release days, though they’ve still been volatile sessions, according to Jake Gordon at Bespoke Investment Group. That means “we’re still far from more normal levels of both CPI reports and the market’s reaction to them,” he wrote.
Equities have been rallying in recent weeks, with growth stocks outperforming since the start of the year. But they could come under pressure if the CPI print comes in hotter than expected, says Ellen Hazen, chief market strategist, and portfolio manager at F.L. Putnam Investment Management.