The history of financial markets is littered with modestly higher CPI numbers that failed to cause any volatility. Today is shaping up to be quite the exception. Despite coming in only 0.1 higher than expected at the core level, CPI sent bond yields screaming higher with 10’s briefly touching 2.0%. Stocks also tanked, making for a quintessential pattern that gives away the market’s rationale.
Simply put, it’s all about the Fed. (In case it’s not clearly implied, the big vertical spikes in the following chart coincide with this morning’s CPI data).
In other words, this morning’s CPI is turning out to be a referendum on the pace of Fed policy. The market was already debating the possibility of a 50bp rate hike from the Fed in March. It was fairly easy to push back against that idea last week. Fed Funds Futures didn’t suggest much of a chance and several Fed speakers said it wasn’t necessary. Now this week, we have a few speakers saying anything is on the table, including a 50bp hike.
Data surprises aside, the shift in Fed Funds Futures for the March meeting has been stunningly linear since December. Days like today merely serve to add an abrupt adjustment, but one that remains in the confines of the broader trend.
But back to the question of why a measly 0.1 beat in CPI ended up causing one of these abrupt little shifts. That remains a bit of a mystery. It requires hindsight analysis. Sure, we knew that CPI had plenty of market moving potential ahead of time, but this seems a tad overdone based on the results. We can speculate that traders hoped for things to moderate given the higher core annual expectations (5.9 forecast vs 5.5 previously). So when the number hit 6.0%, it was not only a psychological plateau, but also an entire HALF POINT higher than last month (granted, some of that is due to base effects–i.e. a weaker month dropping out of the 12-month calculation–but those sorts of “yeah buts” get pushed to the side when the bears are running).