The CPI inflation rate should continue its rapid descent on Thursday. Wall Street economists forecast that consumer prices remained flat or possibly declined in December from the prior month. That should clear the way for a continued S&P 500 rally. Although Federal Reserve policy looms as a risk for investors, Chair Jerome Powell passed up a chance to push back against markets’ bullish move since last Friday’s jobs report.
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CPI Inflation Rate Forecasts
A flat monthly reading for the consumer price index would bring the annual CPI inflation rate down to 6.6% from 7.1% in November. The core CPI inflation rate is expected to rise 0.3%. That would push the core CPI inflation rate down to 5.7% from 6%.
The CPI inflation rate peaked at 9.1% last June, while the core CPI inflation rate hit 6.6% in September, both 40-year highs.
A number of economists predict that Thursday’s CPI report will show an outright decline in prices. Aneta Markowska, Jefferies chief financial economist, expects the overall CPI to dip 0.1% amid further slippage in energy, used car and medical services prices. Food prices are still on the rise, but Markowska expects a more moderate 0.4% increase there.
Deutsche Bank economists expect a 0.15% monthly dip in the CPI, with a 0.2% rise in the core CPI. That would pull the annual CPI inflation rate down to 6.3% and core inflation down to 5.6%.
Fed’s Powell Puts Focus On Wage Growth, Not CPI
A further decline in the CPI inflation rate will grease the wheels for the S&P 500’s move higher, but it isn’t the catalyst.
Wage growth has become key to the Fed policy outlook, so investors celebrated after the December jobs report showed a sudden downshift in Q4. The average hourly wage rose 4.6% from a year ago, below 5% forecasts, kick-starting the current S&P 500 rally. Wage growth has now fallen to the lowest level since August 2021, sliding a full percentage point from the March peak.
With wages growing at an annualized 4% rate in Q4, wage growth appears to be receding to close to Powell’s target of 3.5%. Factoring in productivity growth of about 1.5%, wage growth of 3.5% could bring inflation close to in line with the Fed’s 2% goal.
Powell Tolerates ‘Short-Term’ S&P 500 Rally
On Tuesday, while speaking at a conference on central bank independence, Fed chair Powell passed up an opportunity to pour a bucket of cold water on the new S&P 500 rally. Market strategists had been on high alert for Powell to push back against the hope that the softer wage growth seen in Friday’s jobs report is a game-changer for Fed policy.
Minutes from the Dec. 13-14 policy committee meeting made clear that the Fed won’t welcome a big stock market rise. “An unwarranted easing in financial conditions,” the minutes said, “would complicate the Committee’s effort to restore price stability.”
The Fed isn’t happy that Wall Street is betting on a pivot to rate-cutting in 2023. That clashes with policymakers’ insistence that rate cuts will be off the table until 2024.
The Fed’s worry is that a big rise for the S&P 500 and a further drop in market interest rates will support consumption and hiring. The Fed thinks it will have to push the unemployment rate up a full percentage point to 4.5% to put its inflation goal within reach.
So why didn’t Powell push back against the S&P 500 rally? During his Dec. 14 news conference, Powell was asked whether a recent easing in financial conditions — higher stock prices and lower Treasury yields — was a problem for the Fed as it battles inflation.
Powell responded that the Fed’s “focus is not on short-term moves, but on persistent moves.” In other words, Powell doesn’t see a need to micromanage financial market fluctuations. However, he added that the path of future rate hikes won’t depend on economic data alone, but also on “where we see financial conditions.”
S&P 500 Rises Toward Key Level
The S&P 500 rose 0.8% in Wednesday afternoon stock market action. The Dow Jones Industrial Average added 0.4%, while the Nasdaq composite gained 1.3%.
The rally sparked by the jobs report has lifted the S&P 500 within about 1% of its 200-day moving average. The past couple of rally attempts have faltered at that level, but this one might have some legs.
The S&P 500 finished 9.6% above its Oct. 12 bear-market closing low on Tuesday, but remained 18.3% below its all-time closing high.
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Once the CPI report is out of the way, the next big risk for markets probably won’t come until the Fed’s Feb. 1 policy decision. Markets are now pricing in nearly 80% odds that the Fed will hike its key rate by just a quarter-point.
That seems almost certain, given slower wage growth and data showing a broad economic slowdown is underway. The risk lies in the Fed’s guidance about the policy outlook. Fed projections released last month showed that the federal funds rate would rise to 5%-5.25% this year and stay there until 2024. Yet markets are betting that the key Fed rate will peak at a range of 4.75%-5% in May and fall to 4.5%-4.75% by year end.
Markets aren’t necessarily wrong. A tougher slog for the U.S. economy and lower inflation than the Fed expects could shift the outlook. However, updated Fed guidance and the January jobs report due out two days later will test the durability of this S&P 500 rally.
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