1/11/24, 12:36 AM CPI Preview: A Core Print Above 0.

3% Would Spoil The Party | ZeroHedge

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CPI Preview: A Core Print Above 0.3% Would Spoil The Party

BY TYLER DURDEN THURSDAY, JAN 11, 2024 - 03:01 AM

While it's not expected to be a major market mover (certainly not comparable to the shock CPI prints of 2022 and early
2023), tomorrow's inflation print could lead to quite a few stop outs if it comes in hotter than expected.

Headline CPI is expected to accelerated in December, rising 0.2% vs the 0.1% increase in November, while core
CPI is seen rising +0.3% M/M, matching the 0.3% November increase. There is little dispersion between the
estimates, with the highest core CPI forecast at 0.3% and the lowest at 0.1%, which probably means we get either a
0.4% or a 0.0% print tomorrow.

This translates into a 3.2% increase in headline CPI (that would still be above the YTD low of 3.0% hit in June), and
an increase from the 3.1% in November, while headline CPI is expected to dip from 4.0% to 3.8%, the lowest since May
2021.

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Inflation is approaching the Fed’s 2% target sooner than economists had expected: in fact, in November, the Fed's
preferred inflation measure, the core personal-consumption expenditures index, slipped below the 2% target, sliding
to 1.9% on a six-month annualized basis, due to continued weakness in goods prices offset by services.

Turning to the specifics of the report, in its CPI preview note, Goldman expects a 0.27% increase in December core CPI (vs.
0.3% consensus), corresponding to a year-over-year rate of 3.87% (vs. 3.8% consensus). The breakdown among the CPI
basket categories is as follows:

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Goldman highlights three key component-level trends for the December report

Used car prices are expected to decline by 1.1% and new car prices to decline by 0.2%, reflecting rebounding
promotional incentives and declining used car auction prices in December.

Airfares are to increase by 5% this month, reflecting an increase in Goldman's real-time measure of airfares (unclear
what the airlines how the airlines are justifying the higher costs: is it to buy more convertible airplanes?).

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Shelter inflation will slow somewhat relative to last month (Goldman forecasts both rent and OER to increase by
0.45%), as the gap between rents for new and continuing leases continues to close.

Elsewhere in the report, Goldman expects apparel prices to decline 0.3%, reflecting elevated promotional activity
during the holidays; it also expects car insurance inflation to decelerate to 0.6%, as premiums have nearly caught up
to repair and replacement costs. The bank's forecast is consistent with a 0.23% increase in core PCE in December.

Going forward, the bank sees further disinflation in the pipeline from rebalancing in the auto, housing rental, and labor
markets, though there will be a small offset from a delayed acceleration in healthcare. Goldman expects year-over-year core
CPI inflation of 2.9% and core PCE inflation of 2.2% in December 2024.

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In terms of the market’s reaction function, Goldman trader Cullen Morgan is out with a note (available to pro subs) in which
he makes the following market reaction prediction (the option-implied move through tomorrow’s close is ~0.73%).

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JPM's market intel desk is likewise ready with its own analysis (link here) for pro subs, this one however looks at headline
CPI not core as the key variable:

Headline MoM prints 0.4% or higher. The first tail-risk scenario would likely reflect an acceleration in Core Services
with less of a decline in housing. If this comes to fruition, would look for the bond market to fully remove any probability
of a January rate cut, down from 4.5%, and would see a material decline in March expectations, too, which are currently
pricing ~63% chance of a cut. Yields would back up and could see a 15-20bps 1-day move in yields. Equities would
predictably sell off in this scenario with Defensives outperforming on the move lower. Further, we may see the
stagflation narrative return as well as heightened expectations of a hard landing since the implication would be a likely
resumption of the Fed hiking cycle if you saw consecutive prints like this. Probability 5.0%; SPX loses 1.5% - 2.25%.
Between 0.3% - 0.4%. This would be the hottest MoM print since the October 2023 print, where the SPX fell 4.8% from
CPI day through month-end. While this type of print would spike bond yields and push stocks lower, it would still need to
be followed up with one or two more similar prints before there would be credible risk that the Fed resumes the
tightening cycle. Also, the detail here would matter, e.g., is this an acceleration of Core Services or Housing prices, or
perhaps a lack of decline in things such as Used Vehicles or Public Transportation. Probability 25%; SPX falls 75bps
– 1.25%.
Prints in line with consensus, 0.2% – 0.3%. I think this is a net positive for markets despite this showing inflation
sticking around the 3%; investors are away of the lag between housing prices and official inflation prints. Further, this
would further cement that inflation is “cured”. Our colleagues in JPM Private Bank, led by Tom Kennedy, tell us that over
the last 6 months, Core PCE is running at 1.9%. Further, if you replace the lagged shelter components with proxies of
real-time rents, such as Zillow, then Core PCE is at 0.8%. Probability 45%; SPX adds 50bps – 75bps.
Between 0.1% – 0.2%. This dovish outcome would also suggest that Headline YoY CPI prints below 3%, a large
psychological level for investors. Positioning is no longer the tailwind it was during the 23Q4 rally, but this triggers a rally
as well as bringing stronger March rate cut expectations. The final piece to the analysis would be what the Fed does
with QT, but this could foreshadow the resumption of the 2023 rally and put all-time highs back to top of mind.
Probability 20% SPX adds 1% - 1.25%.
Prints below 0.1%. Another tail-risk scenario, likely driven by a larger than expected decline in Core/Super Core
inflation. The implication would support recent statements from the Fed’s Bostic that inflation is falling more quickly than
expected. This could also trigger a 20-25bps decline in the 10Y yield and would likely be the catalyst needed to take out
5k in the SPX in 24Q1 unless earnings crater. Probability 5.0%; SPX adds 1.5% - 2.50%.

Focusing some more on how the market may interpret the numbers, here are three observations from Goldman traders:
Dom Wilson (Senior Macro Advisor)

Our overall macro backdrop is a benign one and so we continue to look at equities generally from the long side.
The market overshot a little late last year in pricing that story, and looked a bit vulnerable to a back-up in rates, but
with a bit of turbulence over the turn of the year, the equity set-up has looked a bit better coming out of
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payrolls and moving towards earnings. The market’s obviously taken a lot of credit already for the inflation
relief story over the last couple of months, and so the set-up for CPI specifically looks a bit more balanced
than in the last two releases. Our forecast is a touch above the market on headline, and at 0.27% - rounding to
the 0.3% consensus – not very different on core, though we expect some declines in shelter inflation which would
be reassuring. My guess is you could still get modest relief on that outcome, but I’m less sure about that than in
November and December. A higher print could challenge the optimism about a cut as soon as March, but I still
think the threshold to shake the broader narrative is quite high and any downside surprise here is going to
help a market that’s backed off rate cuts a little coming into 2024. For me that means that it continues to make
sense to position long here into earnings – the CPI print shouldn’t change that (and could help) even if it’s less
obvious that it will be as helpful as the last two.

Joe Clyne (US Index Vol Trading)

Heading into CPI, the desk likes long vol and short delta implementations. While the desk thinks that dealers are
still long gamma, the bulk of that long gamma exposure is to the upside here. We think that on a hot CPI print,
the gamma profile cleans up considerably to the downside leaving us freer to extend a move. The straddle
going into tomorrow in SPX is around 70 bps which seems like a slightly better own than sale to us, but 1-3m
vol looks better than gamma here. Flows have been tilted towards buying the CPI move across all three major
indices, with 12Jan buyers in SPX, RUT, and NDX. Our favorite trades are Jan downside in SPX or Feb ATM vol in
QQQ.

Rich Privorotsky (EMEA Cash Equity Trading)

Certainly not the January effect the equity market was hoping for to start 24.The retracement in yields and
especially in the context of still firm AHE and NFP is mildly problematic for stocks. This has really been
exacerbated by the extent of the markets upward moment in Nov/Dec. Rate compression drove a chase for beta.
Big picture there really hasn’t been a period in 23 where bonds were trading lower and equities were trading
higher. Currently some concerns of growth slowdown (JD/MBLY/move lower in cyclical) but think equities
can digest slower growth…the Fed has a lot of potential to ease and has clearly shown their intention to be very
reactive given their Q4 pivot. Higher inflation and higher rates are still much more punitive for equities and
very much out of consensus (if some of the recent market surveys are anything to go by). An annual
upward reset in wages and prices is a tail risk that the market is under-pricing. CPI will be a critical event for
equities, consensus seems to be in a tight range between 3.7-4% on core with almost everyone modeling
sequential deflation. From the cheap seats some of the longer dated inflation pricing looks low to me. No edge on
CPI this week but positioning backdrop in stocks is challenging in the short term.

Josh Schiffrin (Macro Trading Strategies)

While the CPI numbers month to month have been very noisy and its possible there is a ‘start of year’ effect in the
January numbers that exceed that expected by the seasonals, I don’t think locally higher price readings will
take the Fed off a course to ease policy. Given that the 6 month numbers for Core PCE are running around
2% the cumulative disinflation over that horizon, plus Powell’s statement that it makes sense to ease
policy before inflation is fully at 2%, makes clear both the case and the strong bias to ease policy. I think it
would take a bigger reassessment of the outlook to take the FED off an easing course – for example a sharp
upturn in energy prices accompanied by much stronger than expected growth and inflation readings. I view such a
scenario as unlikely and thus the local volatility in the inflation numbers will affect the market through the pace and
cumulative amount of easing in 2024 – rather than on whether the fed eases at all. On wages, I view the monthly
average hourly earnings series in the employment as volatile and ECI as providing the better read that the FED
(and market will follow) and there is only 1 reading before the March meeting (covering q4 in late January). Given
plenty of signs of labor market decelerating I don’t think the higher print in last week’s payroll report will materially
affect the FED’s decision making process.

***
We end with some recent Fed comments on Inflation:

Bostic comments from Jan 8 (BBG) – at this point, shorter-term measures of inflation, such as over three-six-months,
are more important. They are pointing in a positive direction. Many economic measures are back at levels seen in the
years immediately before the pandemic.
Fed's Bostic says inflation has come down more than he expected
Bostic: I see two quarter point rate cuts appropriate by end of year.
Bostic says he expects first rate cut in third quarter
Bostic open question on whether asset runoff pace should change

Bottom line: a hawkish print is more likely than a dovish print. Even so, the trends are clear that disinflation is
entrenched in the economy until there is either a i) commodity prices shock, driven most likely by some geopolitical
Black Swan, Middle-eastern escalation, etc or ii) a shock and awe stimulus by China. The pushback this view would
see was voiced by JPM's Market Intel desk, according to whom a credible exogenous shock to commodity prices would be
one that takes WTI through $100/bbl, as only then will there be a strong enough consumption impulse from the US
Consumer to take headline inflation above 4%, which JPM feels is a necessary pre-condition for the Fed to resume its hiking
cycle.
Much more in the preview folder available to pro subscribers in the usual place.

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