Yesterday's inflation report came in cooler than expected – a 3.3% year-over-year rise versus the 3.4% economists had predicted. Good news, right? Well, someone forgot to tell the bond market.
Treasury yields climbed anyway – with the 10-year jumping about 8 basis points at one point. Stocks initially celebrated the inflation news before surrendering some gains as bonds sold off.
Having covered financial markets for nearly two decades, I've seen plenty of days when market reactions make perfect logical sense. This wasn't one of them.
The playbook here should be simple: lower inflation leads to increased likelihood of Fed rate cuts, which drives yields down and equity valuations up. But markets, those temperamental beasts, rarely follow our neat little scripts, do they?
What we're witnessing is a classic case of conflicting narratives. On one hand, moderating inflation supports the soft-landing scenario – the Fed's medicine is working without killing the patient. Great for stocks! But flip the coin, and if the economy stays resilient enough to avoid recession, maybe we've gotten ahead of ourselves pricing in those rate cuts everyone's been counting on.
Look, before yesterday's CPI report, markets had baked in roughly 100 basis points of Fed easing for 2024. That's not just optimistic – it's practically wearing rose-colored glasses while riding a unicorn.
Dig into the actual inflation report and the picture gets murkier. Shelter costs? Still up 0.4% month-over-month. Services inflation? Stubbornly sticky. Core CPI? Running at 3.9% year-over-year – still miles from the Fed's 2% target. As Powell keeps reminding us (perhaps to the point of annoyance), the path back to target inflation will be "bumpy" and "take some time."
Then there's the technical stuff. This week's Treasury auctions weren't exactly blockbusters. The 10-year auction saw demand that could generously be described as... lukewarm. When you're trying to sell government debt and buyers aren't exactly fighting each other to get in the door, yields naturally rise to attract capital.
And let's not forget about Uncle Sam's spending habits. The deficit isn't shrinking – it's expanding. Someone has to fund it, and that someone is increasingly domestic investors rather than foreign central banks. Translation: Treasury needs to sweeten the pot with higher yields.
What fascinates me is how equity markets seem determined to focus on the rainbows while ignoring the storm clouds. S&P 500 flirting with all-time highs? Sure! Magnificent Seven tech stocks trading at multiples that would make even the most optimistic 1990s analyst blush? Why not! Pay no attention to those pesky bond yields sending a somewhat different message.
We're living through what historians will probably call a major regime change in macroeconomics. After 15 years of disinflation, zero rates, and central banks printing money like it's going out of style, we're navigating a world of higher inflation, higher rates, and central bankers trying to find neutral without causing a crash landing.
It's like watching someone who learned to drive in Kansas suddenly navigate the hills of San Francisco. In a manual transmission. During rush hour. In the rain.
These transitions between monetary regimes? They're rarely smooth sailing. Markets develop habits – muscle memory – based on the old rules. Those muscles are still figuring out new patterns.
So what's the takeaway for investors? First, the glide path to lower rates will be bumpier than many hope. Second, the tug-of-war between equity optimism and bond market caution isn't going away anytime soon. Third, expect more volatility as these competing narratives duke it out.
I've noticed over the years that when stocks and bonds send contradictory signals, there's wisdom in at least considering the bond market's side of the story. Fixed income folks tend to be the more sober-minded crowd – maybe too pessimistic sometimes, but rarely caught up in irrational exuberance.
Then again, I've been wrong before. (Just ask my ex-wife about that tech stock I insisted would "revolutionize everything" right before the 2000 crash.) Maybe equities have it right and we're headed for that mythical soft landing where inflation magically returns to target, growth purrs along, and the Fed delivers all those rate cuts. Stranger things have happened... though I'm drawing a blank on examples.
For now, keep an eye out for Powell's next public appearance. The man has developed quite the knack for throwing cold water on markets when they get too excited. Something tells me he's practicing that particular skill as we speak.
