• Monthly consumer price index surprisingly accelerated in January.
• Probability of rate cuts in the first half of the year diminished markedly.
• Disappointing inflation data sparked meltdown in equity markets.

The consumer price index (CPI) rose more-than-expected in January as shelter costs, which accounts for one-thirds of the index and healthcare picked up. The underlying CPI accelerated 0.3% last month, up from 0.2% reading in December, according to the Bureau of Labour Statistics. On an annual basis the CPI increased 3.1%, down from 3.4% in December. Both metrics came above market expectations of 0.2% monthly and 2.9% annual rise.

The monthly core CPI which excludes the volatile food and energy prices increased 0.4% from 0.3% the prior month. The annual core CPI came up 3.9% and remained unchanged from December. Both readings exceeded market expectations of 0.3% a 3.5% rise respectively.

Source: TradingView, Bureau of Labour Statistics, Inflation Rate YoY

While inflation is broadly moderating from its peak of 9.1% in June 2022, the path to the Fed’s target of 2% may be bumpy. The increase in prices in January was the largest over the past four months amid robust labour market and resilient economy. While the higher readings are disappointing, businesses usually increase their prices at the beginning of the year, making January usually a strong month for inflation.

In our view, the longer-term trend of moderating inflation is intact, and the January data is insufficient to suggest a resurgence in inflation. Also, not all of the components that drove inflation higher in January would go in the calculation of the personal consumption expenditures index (PCE), which is the Fed’s preferred measure of inflation.

Nonetheless, the disappointing CPI report together with the latest strong non-farm payroll report, triggered market repricing of rate cut expectations to fall to 90 basis points(bps) from 160 bps at the end of 2023.

After the hotter-than-expected inflation data, the slim chances that the Fed could start lowering interest rates in the first half of the year have diminished further. A March rate cut is now completely ruled out, while hopes for a cut in May decreased markedly. According to the CME FedWatch Tool the odds for a March rate cut are now at 8%, while the probabilities for a cut in May declined to 32%.

Source: TradingView

Equity markets nosedived on Tuesday as the disappointing inflation data report dampened investors’ hopes of a rate cut in May, just a day after stock indices posted fresh record highs. Investors were widely expecting four to five interest rate cuts in 2024 according to the CME FedWatch Tool, while Fed officials have been repeatedly reinforcing that the central bank envisions three rate cuts at the most.

Markets ignored the Fed’s warnings that rates are staying higher for longer and have created the biggest discrepancy between policymakers and investors expectations. The latest CPI report threw a backet of cold water on these expectations and respectively on the market rally which has been unfolding almost uninterruptedly over the past fifteen weeks.

The relentless rally pushed the benchmark U.S. index to an all-time high of 5,048 on Monday, marking a gain of 23% since its October low. On Tuesday the market tanked 1.4% and the pull back is likely to extend further in the short-term as we see signs of exhaustion in momentum. A triple bearish divergence between the price and the Relative Strength Index (RSI) has formed over the past two months suggesting that the rally is losing steam, which points to a potential deeper pull back in the short-term.

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