Inflation rose for the second money in row in August, driven higher by rising energy costs — so stocks must have fallen, right? Not exactly. Broadly, stocks rose this morning, led by the tech sector which saw Amazon hit a new 52-week high. Other notable stocks outside the tech sector, like Walmart, also hit a new 52-week high. Contradicting the rising price of the commodity, energy sector stocks were the laggard today. Rates were mixed, with the 2-year note yield falling and the 10-year rising, which meant the yield curve became slightly less inverted. That means the market took this news positively — why is that? Let’s take a look below.
Inflation Overview in August
- CPI rose +0.6% in August, its largest monthly increase this year.
- Year over year headline inflation rose 3.7%.
- Core CPI (a measure of inflation without food and energy) rose 0.3% in August, and 4.3%.
- Simultaneously, average hourly earnings declined 0.5% for the month. Typically that’s a welcomed sign that the labor market is easing, however in this instance, it shows that consumers were forced to bear the brunt of price increases.
- Energy saw the biggest monthly gain, with the price at the pump rising 10.6% (gasoline), and energy as a broad category rising 5.6% on the month.
- Food prices rose 0.2% on the month.
- Shelter rose 0.3%, with rent (primary residence) rising 0.5% on the month and 7.8% year over year.
- Airfares rose 4.9%, but are still lower year over year by -13.3%.
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Notably, while the largest monthly gain came from energy, the largest component of inflation’s yearly increase is in shelter costs. Excluding shelter from the CPI would have meant a year over year CPI of roughly 1%, rather than the 3.7% we’re seeing currently.
Market Reaction to the August CPI
Stocks Rise, Growth Stocks Outperform
The market reacted fairly positively to today’s news — a far cry from how markets reacted in 2022 to hotter-than-expected inflation prints. The tech sector led the gains, with QQQ rising 0.53% by mid day, and several “growth names” (which in the past have reacted poorly to higher-than-expected inflation) outperforming. Names like Nvidia (+1.7%), Amazon (+1.99%), and Tesla (+1.38%) were notable outperformers.
Contrarily, names in the energy space — the space that contributed the most to August’s monthly pricing increase — were today’s laggards. Exxon fell -0.86%, Schlumberger fell -2.53%, Occidental Petroleum fell -0.75% and the XLE SPDR ETF fell more than 1% on the day.
FedWatch — Fed Rate Futures
Despite the rise in inflation, the odds of a September rate pause remained priced-in at 97%. Even more curiously, the odds for November’s FOMC also continue to lean towards a pause, at 57.9% to 42.1%.
Zooming out, the market continues to see the first rate cut coming in June, another 25 basis point cut in July, and by December of next year, the market expects rates to have dropped from 5.25-5.50 (current) to 4.25-4.50 — a full basis point, or “four” 25 basis point cuts.
Treasury Yields Drop
Source: MarketWatch
Yields, which often rally in the face of inflationary headlines, fell today on the news, with the 2 Year dropping -1.25% from the previous close and the 10 Year dropping -0.70% on the news. Not only did both notable yields drop, the 2 Year dropped nearly twice as much, signifying a shrink in the yield curve inversion. When yield curves invert, that’s often a recessionary indicator — the fact that the yield curve inversion is reducing in size is a positive sign, and it gives us insight into why the market reacted positively today.
Why the Market is Comfortable with August CPI
Prior to the August CPI report, we received a slew of potentially worrisome inflation reports regarding the labor market. We saw the labor force participation rate increase rapidly, we saw unemployment rise, we saw average hourly earnings decline, and (before the two most recent prints) we saw an entire year of falling CPI data. While the Fed wants to fight inflation, they’ve been clear that they have to strike a careful balance between defeating inflation, and economic stability. The Fed doesn’t want to drive the market into a recession. To put it simply, today’s data bolsters the case for a soft landing.
It can be easy to forget after the past year and a half, but economically, some inflation is a good thing, particularly for businesses. Some inflation means that demand is high, and the economy is strong enough to support that. When panning out to the bigger picture, if today’s CPI print came in far below expectations, it may have signaled to some that the odds of an economic “soft landing” were lower — that the economy was weakening at too fast a rate for it to handle, and that more trouble was ahead. Instead, we saw data that shows the Fed isn’t completely crushing demand, and the broad trend of inflation continues to be lower even with August’s increase. The bottom line: August CPI shows that the economy is continuing to hold up against the brunt of Fed monetary tightening, inflation is slowing (but not “falling off a cliff”), and the possibility of a “soft landing” is still on the table.
