Global Equity Weekly

January 12, 2024 | 17:31

Sticky Inflation Situation

Economist

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Equity markets pushed higher this week as investors continue to zero in on 2024 rate cuts, and despite sticky U.S. inflation results. The S&P 500 gained 1.8%, and is within close striking distance of an all-time high. The Dow continues to bounce around near record levels, while the Nasdaq still has about 7% to climb. The TSX also has some more work to get there, and underperformed with a 0.3% advance this week. Technology, communication services and consumer discretionary led North American markets on the week, which naturally leads to the Canadian market lagging.

On the data front, the key U.S. CPI report was firmer than expected in December, though a softer PPI report cooled the sting somewhat. Headline inflation picked up to 3.4% y/y from 3.1% y/y in the prior month (consensus was 3.2%), largely because of a weak year-ago print (month-over-month CPI was a modest +0.3%). Core inflation was also a touch firmer than expected at 3.9% y/y, though still down from 4.0% y/y in the prior month and the first 3-handle since inflation was really flaring higher in mid-2021. We continue to see softness in core goods inflation (+0.2% y/y); while core services (+5.3% y/y) are still very sticky. Overall, the +0.3% monthly print leaves core CPI running at 3.3% annualized on a 3-month basis; and 3.2% a.r. on a 6-month basis. Drilling further, the ‘supercore’ measure (core services ex-housing) was firm again and is running at 4.3% a.r. over the past three months—still improving, but doggedly slow.

All in, not a game-changer CPI report for the Fed, which is firmly on hold. They’ll need to see some further sustained progress on inflation before they seriously consider rate cuts… progress does continue, but there are still too many 3- and 4- handles on the various inflation metrics over the past 3-months to suggest cuts are imminent. We’re still leaning more toward a mid-year start with the bulk of easing in the second half of the year, and think the market might have gotten ahead of itself pricing in cuts.

That said, with the Fed firmly on hold for now, and core inflation gradually drifting down, real policy rates continue to drift up. As of December, the real fed funds rate, as measured by the difference versus year-over-year core CPI inflation, edged up further to 1.5%. And, with 3-month annualized core inflation running around 3.3%, there is about 0.6 ppts of further ‘real tightening’ coming down the pipeline under current conditions. Real rates are now at the highest level since 2007, and we’d argue that the 1.5%-to-2% range is restrictive enough (squarely in between the peaks of the 2007 and 2019 cycle ends). So, it’s easy to see why the Fed could/should take some tightening out of the system, if for no other reason than to maintain recent real rates. But, move too soon, and easier financial conditions could jeopardize a lot of the progress already made on inflation. The latter argues for a bit of patience still…

Major Index Performance

North American Sector Performances

(% change over period)

Table 1 - S&P 500 Sector Performance

Source: BMO Economics, Bloomberg

Table 2 - TSX Sector Performance

Source: BMO Economics, Bloomberg

TSX Relative Sector Performance

(relative to the index, year-ago = 100; dashed line = 200-day m.a.)

S&P 500 Relative Sector Performance