More Muted Market Reaction to Cooler Inflation Data

Posted by George Smith, CFA, CAIA, CIPM, Portfolio Strategist

Wednesday, December 14, 2022

Equity markets responded to yesterday’s cooler than expected inflation data in similar, but eventually much more muted, fashion to how they responded earlier in this rate hiking cycle. November’s core Consumer Price Index (CPI), which excludes food and energy, came in at 6.0% year over year, below estimates of 6.1%. So far in this rate hiking cycle, cooler inflation data has boosted markets, and especially rate sensitive sectors, based on market participants’ belief that slowing inflation data could give cover for the Federal Reserve (Fed) to slow the pace of interest rate hikes sooner rather than later.

The S&P 500 has posted average returns of 2.4% when core CPI surprised to the downside, as it did yesterday, so initially it was little surprise when markets surged around 2.7% shortly after the open. What is perhaps telling, in the way that the narrative has shifted from worries over inflation to concerns over the strength of the economy and recession risks, is that the early gains largely evaporated as the day wore on with the S&P 500 closing just off its worst levels on the day, and up only around 0.75%. This is a very different market response to last month when the softer October CPI data spurred a daily jump of 5.5% in the S&P 500, a record gain on a CPI release date, closing at the daily high.

The bar chart highlights the average daily return of the S&P 500 and its sectors for all CPI release dates since the Fed began raising rates in March 2022. The returns are bifurcated between days when year-over-year core CPI came in above or below estimates.

View enlarged chart

At a sector level, yesterday’s market returns followed a similar pattern to earlier in the rate hiking cycling but with some undercurrents exhibiting a shifting narrative in the markets. Consistent with this rate hiking cycle so far, consumer staples was the worst performing sector and the only sector down on the day (-0.17%). Healthcare has also been a laggard if inflation has surprised to the downside and it was a similar story yesterday. The biggest surprise was consumer discretionary, which has averaged a return of around 3.9% if inflation has printed lower than expected, but was the second worst performing sector on the day, only seeing a modest pickup of 0.2%. This is a further manifestation of the waning importance of the inflation data and of increasing concerns over the economy and the ability for consumers to keep spending at the current pace if there is a recession.

Real estate (2%) continued its strong performance on days when CPI surprised to the downside and was the top sector of the day, albeit with much more muted daily returns than the average (3.2%) seen earlier this rate hiking cycle. Energy (1.8%) and communication services (1.7%) were the only other sectors that saw daily increases of at least half of the average we have seen earlier in the rate hiking cycle when inflation came in cooler than expected.

Equity market reaction to inflation data so far this rate hiking cycle has really been a reaction to how markets expect the Fed will respond to inflation data, hence all eyes will be on the Fed today to see if the last two inflation data releases have been enough to sway their actions at all. Today the Federal Open Market Committee will release their updated forecasts for economic growth, inflation, and interest rates. We expect for the Fed to push back on some of the more aggressive market expectations for a pause or pivot in the near-term.


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