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CPI Exceeded Expectations

The CPI topped forecasts, dashing hopes of a reduction in interest rates by May. June has been pushed to July.   As little as three weeks ago, the market was suggesting that a March reduction “was a given.”

The market’s timetable is starting to align with that of the Fed—mid to late summer.  “The market” is still suggesting at least four reductions will occur in 2024, the mantra something along the lines as “more and bigger later.”  As noted many times, the Committee is only suggesting two or three interest cuts may occur.

The core-CPI, which excludes food and energy, increased 0.4% from December, more than expected and the most in eight months.  From a year ago, it advanced by 3.9%, the same as the prior month.  Analysts had expected a decline to 3.7%.

The overall CPI rose 0.3% from December and 3.1% from a year ago, exceeding expectations of a 2.9% print.

OER (owners’ equivalent rent) which is the largest component of the CPI rose by 0.6%, the greatest increase in nearly a year.

As widely noted the Administration reconfigured how inflation is calculated, placing a greater weight on OER.  About 15 months ago, economists had expected OER during 2023 to decline, hence a tailwind for a drop in inflation.  OER is accelerating.

Every Administration has reconfigured how the data is calculated but is widely accepted the current Presidency is doing it on steroids offering great credence to the view that the data has been corrupted by politics.

Several months ago, the media made great fanfare that the “Super Core CPI” was not accelerating at the pace as the core CPI  [Super core is CPI ex food, energy and shelter).  Many have never heard of the “Super Core CPI.” 

Prices based upon this metric reaccelerated to a 4.3% pace from the prior year, the fastest since May.  The monthly pace rose by 0.85%, the greatest increase since April 2022.

The disinflation narrative had been dominating the markets since October and is a major reason as to the unrelenting advance in the “Magnificent Seven” and technology stocks.  Bloomberg writes active money manager allocation to technology is the highest since August 2020. The 10 largest companies now comprise a record 32% of the S & P 500 capitalization.  The Magnificent Seven is valued at 50% of the country’s GDP.

This is nuts.

As noted the other day, 90% of equity trading is done algorithmically, trading that does not care about value but rather momentum and where shares may be priced in 15 minutes.  Over 50% of the market is now in passive index funds, funds that don’t have price discovery, where by definition the big get bigger as prices go higher creating an very imbalanced market.

Always expect the unexpected.  What are the odds the Fed does not lower rates this year as inflationary pressures mount partially from increased costs and bottlenecks from violence on the high seas?  Ocean travel is now the most dangerous since January 1945 as violence has spread to the Horn of Africa, the Indian Ocean and some parts of the Mediterranean Sea.  The world is still interconnected.

Will volatility rise dramatically, volatility that is exacerbated by the lack of liquidity and concentration of funds in one sector?

The markets always face headwinds but appears today that many are too complacent about these headwinds.

Commenting on yesterday’s market action, the Dow and NASDAQ fell 1.3% and 1.8%, respectively.  Treasuries were crushed across the curve with yields broaching mid-November highs.

Last night the foreign markets were up.  London was up 0.83%, Paris up 0.51% and Frankfurt up 0.32%.  China was closed for a holiday, Japan down 0.69% and Hang Seng up 0.84%.

Dow and NASDAQ futures are up 0.25% and 060%, respectively, following the worst day since March 2023 as the markets are perhaps beginning to accept the Fed’s reality of monetary policy.   The 10-year is up 7/32 to yield 4.29%.

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Kent Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.