December CPI is a Bomb for the Market, and You May Sell Anyway

Following the solid non-farm payroll report last Friday, even the lower-than-expected PPI couldn't downplay the market's hawkish pricing for the Fed: no rate cuts are anticipated by June, and perhaps not at all throughout the year. The 10-year Treasury yield is approaching 4.8%, with dollar index reaching a two-year high. On Wednesday morning, the CPI data will set the tone for the market. Regardless of whether the data is better or worse than expected, it should be treated as a sell signal.

What to Expect:

Consensus forecasts call for the headline CPI to increase by 2.9% year-on-year, up from 2.7% the previous month, with a month-on-month acceleration of 0.4%. The core CPI favored by the Fed is expected to remain solid, predicted to grow by 3.3% year-on-year and 0.2% month-on-month.

Investors have placed less emphasis on CPI these days due to the continuing downward trend and the Fed's rate-cut cycle. However, with the economic outlook continually being revised upwards, fiscal stimulus, and potential tariff threats under Trump, if inflation is indeed reigniting, the Fed may need to reassess its monetary policy and shift its focus back toward inflation.

The market is bracing for significant turbulence. Stuart Kaiser, Head of Equity Trading Strategy, suggested that the S&P 500 index might fluctuate by 1% on Wednesday, marking the most volatile CPI release day since the regional banking crisis in March 2023.

Considering the S&P has been trending slightly downward since mid-December, now it's more about the economic figures themselves: the economy is robust, but a continued bull market may need a break. Thus, unless the CPI surprises significantly, the overall tone may again be set to high open and low closing as seen after the PPI, preparing for the upcoming earnings season.

In the short term, Fed rate cuts are unlikely. According to FedWatch, there is a 98% probability of no action at the end-of-January meeting and a 63% chance of no rate cuts before June. If the upcoming CPI fails to meet expectations, it could further solidify hawkish expectations.

In addition, several points should be emphasized in this CPI report.

Firstly, energy prices aren't likely to boost CPI as they have in the past. WTI crude oil has bounced back since mid-December and will affect this report and more in the future. Given there is no significant strategy change by OPEC+ to alter supply, and Trump's policies may not push oil firms to supply more in the short term, the unbalanced oil market may hover for some time and slightly elevate the CPI.

Core CPI is another concern, with a robust job market stressing affordability of higher shelter, airline services, medical care, etc. In the PPI data released yesterday, airline passenger services soared by 7.2% month-on-month, the most significant increase since March 2022, partly influenced by the Christmas shopping season. Delta Air Lines' CEO describes it as "the best year for the company ever." A strong job market and strong spending lead to strong prices.

Another focus is on shelter, which accounts for more than a third of CPI and is an essential component of core CPI. In the November CPI report, housing prices slightly slowed to a 0.3% month-on-month increase but remain the most significant obstacle to decreasing core inflation.

Zumper publishes a national rental report every month, providing a leading indicator (about 6-12 months ahead) for predicting housing CPI. Since the end of March last year, Zumper's one-bedroom rental prices have been on the rise, which may start to be reflected in the housing CPI. The upward momentum is still ongoing, indicating that we may not see a real shift in shelter prices in the foreseeable future.

 

These factors inform investors on their next steps. If the market is boosted by better-than-expected CPI, it's a great time to cash out stocks, at least for now, due to the overall bearish sentiment and persistent core inflation, which may push the Fed to be more hawkish. If the figure is worse than expected, it will signal that inflation is backfiring, thanks to the Fed's easing. Therefore, regardless of whether CPI is good or bad, it's a sell signal for stocks. Given the timing between Q4 earnings season and CPI is so close, some funds may start to cash out as earnings reports are released, even if some show resilient results.

However, some still keep in mind that as the economy outperformed, any correction now is a buy-back opportunity. You should be patient and employ a buy-the-dip strategy once again to ensure that when the correction finishes, you can ride the next bull market.

Overall, the upcoming inflation report carries certain upward risks, including low base effects in energy prices, strong economic pull on autos and housing, and the shopping/travel boom of the Christmas season. Even if inflation merely meets expectations, it could still heighten market concerns about the Fed's future path. Amid global uncertainties, economic resilience, and high-yield U.S. Treasuries, investors may continue to flee to safe-haven assets.