Softer Core CPI Eases Inflation Fears, Boosts Stocks

The consumer price index (CPI) for December 2024 came in softer than expected, with the core CPI rising by 0.4% year-on-year, compared to the 0.5% increase forecasted. This slower pace of core inflation eased concerns about the Federal Reserve's potential tightening of monetary policy, leading to a strong rebound in stock prices on Friday.

The softer-than-expected core CPI reading had a significant impact on market sentiment and investor behavior. The core CPI, which excludes food and energy prices, rose by 0.4% year-on-year in December, compared to the 0.3% rise in the previous month. This was lower than the consensus forecast of a 0.5% increase. The slower pace of core inflation eased concerns about the Federal Reserve's potential tightening of monetary policy, which had been weighing on markets earlier in the week.

As a result of the softer core CPI, investors became more optimistic about the prospects for the U.S. economy and the potential for further rate cuts by the Federal Reserve. This led to a strong rebound in stock prices, with all major indices posting broad-based gains. The S&P 500, for example, rose by 1.1% on Friday, while the Russell 2000, which tracks small-cap stocks, gained 1.2%. The real estate sector led the charge, rebounding sharply after being hit hardest in the aftermath of the Fed meeting. Small-cap stocks in the Russell 2000 also posted robust gains, powered by a strong recovery in regional banks.

In the bond market, yields dropped by approximately 5 basis points across the curve, boosting Treasury prices. The iShares 20+ Year Treasury Bond ETF TLT gained nearly 1%, recovering some ground after a 3% slide over the previous two sessions. The dollar softened, declining 0.6%, while gold gained over 1%.

The dip in core inflation also led to a partial recovery in Bitcoin prices, with the cryptocurrency paring its daily losses and rebounding from steeper pre-market declines. However, it remained on track for its worst weekly performance in four months.

The sectors and assets most affected by the inflation data were real estate, small-cap stocks, Treasury yields, gold, and energy. These sectors and assets were most affected by the inflation data because they are sensitive to changes in inflation and interest rates, which can impact their performance.

The Fed's reaction to the CPI data influenced market expectations for future monetary policy by signaling a potential shift in its stance. When the CPI data came in hotter than expected, the Fed indicated that it might need to raise interest rates more aggressively to combat inflation. This change in tone led markets to price in a higher probability of rate hikes in the near future, which in turn affected asset prices. For example, the yield on the 10-year Treasury note rose sharply, reflecting investors' expectations of higher future interest rates. Additionally, the S&P 500 index fell by more than 1% on the day the CPI data was released, as investors anticipated that the Fed's more hawkish stance would lead to a slowdown in economic growth and corporate earnings.

In conclusion, the softer-than-expected core CPI reading in December 2024 helped to alleviate some of the concerns about inflation and the potential for further rate hikes by the Federal Reserve, leading to a strong rebound in market sentiment and investor behavior. The sectors and assets most affected by the inflation data were real estate, small-cap stocks, Treasury yields, gold, and energy. The Fed's reaction to the CPI data influenced market expectations for future monetary policy by signaling a potential shift in its stance.