Inflation progress: Inches rather than feet

Markets

US equities were stronger Wednesday, S&P up 0.4%, and US 10yr yields down 8bps to 3.44% after US CPI printed in line with expectations. 2yr yields down 11bp to 3.91%.

US CPI printed in line with expectations in April at both headline and core. Year-ended headline a tad lower than consensus at 4.9%, core at 5.5% as expected.

As they often do, investors enthusiastically greeted the news about moderating inflation. However, the positive close looked anything like a sure bet when the S&P 500 settled back down around 4100 in mid-afternoon New York as investors contemplated the implications for the Fed's path from here due to the sticky core.

The details lean softer than the headline as  'lodging away,' airfares, 'household furnishings,' and 'new vehicle' prices all fell in the month. And the Fed should take the moderation in core services, excluding rent, OER, and medical care, as a tentative good sign. 

As far as the big picture is concerned, core inflation still runs at least twice the Fed's target rate over all relevant horizons (3m, 6m, 12m), which is intolerably high. 

Now that we are measuring CPI downward progress in inches rather than feet, is it enough for the rate cut camp? Probably not, as some slowdown in inflation is necessary, but consensus prints are not a sufficient condition to allow the Fed to ease in 2023.

The alternative could have been messy, especially if investors sensed a Fed boxed between inflation concerns and slowing growth. For now, markets seem happy as peak inflation remains a slight tailwind for equities.

So here we are in a range-bound untenable calm measuring inflation progress in fractions as we await the fireworks from the high stake game of geopolitical poker, an acute stateside political game of chicken and the ongoing game of chaos across the US banking centres.

There is no shortage of debt ceiling hand-wringing in Foggy Bottom (Washington DC). Yet, most think the saga will be resolved without any significant disruptions. The presumption is based on history and the view that no elected official wants to wear the scarlet " I started a recession button" heading into an election year.

Numerous problems around US regionals are still unresolved, including the rising cost of funding, concerns around CRE exposure, deposit outflows and looming regulatory changes; the sector remains mired in gloom.

As banks will most assuredly veer toward ultra-restrictive lending behaviour, growth is bound to crack due to the capital impingements, which could see investors turning less optimistic about their stock portfolio.