"Some May Want To Buy Insurance On This Tiny 0.1% CPI Miss That Sparked A Faceripping Rally"

By Bas van Geffen, Senior Macro Strategist at Rabobank

US CPI inflation came in softer than expected, inspiring a rally in virtually all asset classes. The inflation data had been flagged as the key number for the week, and it’s therefore not surprising that the faster-than-expected deceleration of consumer prices led to some repricing of future Fed policy rates. However, we’d argue the move was perhaps a bit outsized for what is essentially just a 0.1 percentage point surprise in CPI.

October CPI inflation came in flat on the month, as the core measure came in a bit softer than expected as well. Whereas the market consensus had expected the gradual decline in core inflation to stall at 4.1% y/y, a slightly softer 4.0% print means that the downtrend that started in March continued through October. The underlying categories give the FOMC no real urgency to resume their hiking cycle.

Indeed, traders were quick to price out any remaining odds of rate hikes in December or January. At one point in time, both futures were even priced for exactly zero chance of a policy change in both months. As a by-product money markets also brought forward their expectations of the first Fed cut: traders are pricing almost one-third chance of a cut materialising by March, and they now expect that we’ll have seen two rate cuts by July. Yet, with inflation still very much above target, the FOMC will have to be patient; if the Fed doesn’t hike, it doesn’t mean they will cut.

This exuberance spread to other asset classes. Treasury yields fell sharply, and particularly the moves in the longer end of the curve were remarkable. The 10-year yield dipped some 15bp after the softer inflation report and the 30-year Treasury dipped some 12bp before recovering a few of these basis points. We flagged the rising term premium in these segments of the curve in earlier notes, and the fact that this reflects higher fundamental uncertainty about the future state of the economy. With that in mind, is everyone happily subscribing to the view that inflation may, in fact, not be permanent – after this one CPI release provides a mere 0.1 percentage point windfall?

Some may want to buy some insurance; especially seeing that this 0.1% undershoot seems insurance-related. The BLS reported a -34% y/y decline in health insurance costs! That hardly seems credible given the trends of ageing population and rising costs everywhere, including in medical care. Instead, the BLS changed its calculation methodology. Even at a weight of just 0.525%, that’s a 0.17 percentage point drag on headline CPI.

As expected, the prospect of lower yields did wonders to equities. The S&P 500 gained 1.9% on the day, while Europe closed 1.6% higher. And this wanting to believe isn’t limited to US markets. After the softer UK CPI release this morning, the SONIA market added to its bets that we will be seeing at least three cuts from the Bank of England in 2024. That said, the deceleration of UK inflation does in fact appear to be driven by lower services inflation – which is a positive sign for the Bank.