Why the Markets Shrugged Off the Latest Inflation Numbers

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Tell me something I don’t know.

That’s the reaction of the bond and stock markets to news that inflation at the retail level was running at a 39-year high in November. Indeed, Treasury inflation-protected securities were saying price pressures in future years will be abating instead of getting worse.

Stocks were mostly higher at late morning, while bond yields fell, following the 8:30 a.m. EST release of the consumer price index, which showed a 6.8% increase from a year earlier, the highest since 1982, while core CPI excluding food and energy costs was up 4.9%, the most since 1991. (Bond yields move inversely to prices.) As bad as those numbers were, they were no worse than what markets were expecting and less horrible than what they were braced for.

The benchmark 10-year Treasury note was trading at 1.45% at late morning, down from 1.51% prior to the CPI print. That came as a relief to the equity markets, where the major averages were mostly up from 0.11% for the

Dow Jones Industrial Average
to 0.68% for the

S&P 500,
while the

Nasdaq Composite
was about unchanged.

The lower bond yield reflected lower inflation expectations, as reflected in the “break-even” spread between nominal Treasury yields and real yields on TIPS, which is the market’s implicit long-range inflation forecast. That indicates the market was looking for an even hotter inflation reading than economists, Mike Schumacher, head of macro strategy at Wells Fargo, writes in a client note.

The 10-year break-even inflation rate contracted to 2.46% from 2.51% before the CPI release, he writes. This continues a trend since mid-November, which shows longer-term inflation expectations easing from a peak of 2.76%, according to the Federal Reserve Bank of St. Louis.

Schumacher further writes shorter-term break-evens also should contract further, suggesting greater near-term inflation relief on the horizon. But, he adds, the bank’s economists don’t see the CPI report changing the view of the Federal Open Market Committee at next week’s meeting.

Along with most Fed watchers, they look for the FOMC to increase their taper of securities purchases, albeit somewhat more gently than some of their cohorts. Wells sees the Fed trimming its Treasury purchases by $15 billion a month and its agency mortgage-backed securities purchases by $7.5 billion. That compares with the reductions of $10 billion and $5 billion, respectively, set at the November FOMC.

Other Fed watchers are looking for the taper to increase to $20 billion and $10 billion, respectively, to wind up the central bank’s securities purchases by March. That would give the Fed the ability to begin the begin raising the federal-funds rate from the current rock-bottom 0%-0.25% target range.

Fed-funds futures’ probabilities of rate hikes in 2022 were hardly changed by the CPI report, which adds to the stock and bond markets’ lack of angst over the data. The liftoff could come as early as May, according to the CME FedWatch site, although June is a better bet for a quarter-point boost. A second hike could come by September and a third is possible by December, unchanged from Thursday’s probabilities. A lot could change by then, however.

Write to Randall W. Forsyth at [email protected]