RBC: Tomorrow's CPI Print Is More Important To The Market Than The Fed

With a 95% implied probability of a rate hike tomorrow, there is little doubt that Janet Yellen will raise rates, although as Goldman previewed two days, there are at least two open issues should make tomorrow's meeting somewhat interesting: First, will Fed officials alter their policy views in response to the increasingly different signals that both sides of the mandate are sending about the urgency of further tightening... and... Second, will the press conference provide some clarity on what the next tightening step following the June hike will be?

But by and far, tomorrow's FOMC announcement will be a non-event, unless - as some have suggested - Yellen tries to collapse the extra easy monetary conditions which as DB and GS calculated recently, are the loosest they have been since 2014, courtesy of the ongoing QE at the ECB and BOJ.

So instead of the much anticipated FOMC, keep a closer eye on tomorrow's inflation report. According to RBC's Charlie McElliggott, the Wednesday CPI print will have a more meaningful impact on the near term direction of the market than Yellen's priced in decision. Charlie explains:

  • A splash of “FOMC Drift / FOMC Alpha” into tomorrow’s Fed meeting, your standard ‘Spooz bid / USD offered’ pre-Fed behavior
    • Further contributing to today’s S&P melt-up was the $57B of calls btwn 2425 and 2475 levels, $20B of which sits at the 2450 ‘gravitational pull’ level into Friday’s expiration (H/T A. Ramsey)
    • Nominal rates a touch lower / curves flattening into the Fed as well -> UST’s VERY firm despite another day of meaningful Treasury issuance ($12B 30Y traded through WI) and ‘pretty-good’ PPI #’s
    • Solid—not spectacular—bounce-back day for equities ‘Momentum’ / ‘Growth’ -> Tech and Consumer Discretionary mega-longs thus two of the S&P’s top sectors on the day 
  • That said, ‘Value’ acted well too, with all four key cyclical sectors-- Materials, Energy, Financials and Industrials—in the top half of S&P sector performance tables on the session
  • Tomorrow’s event risk is actually the CPI print and its impact on forward-looking Fed path
  • Macro backdrop remains entirely focused on the ‘disinflation’ versus ‘reflation’ debate ->’Macro Range Trade’ still exists
  • Fixed-income’s ‘latent-bid’ speaks to expectations for another disappointing CPI print tomorrow and growing-‘consensuality’ of the “slow-flation” narrative
  • CPI likely to dictate the near-term direction of the equities ‘Value / Growth’ factor-rotation in ‘binary’ fashion
  • Better CPI would re-rack ‘reflation’ hopes, drive nominal rates higher and reverse recently-collapsed breakevens
  • Better CPI too would further perpetuate the recent equities ‘Momentum’ unwind: into ‘Value’ (cyclicals) / ‘Size’ (small cap) / ‘High Beta,’ out of ‘Growth’ (secular growers) / ‘Anti-Beta’ (defensives / yield plays) / ‘Quality’
  • Conversely, if CPI comes in ‘soft,’ will crystalize “slow-flation” and may see consensus begin shifting to a Fed ‘one and done over balance of 2017’ view
  • Said inflation disappointment would see rates again grind lower, while equities trade will revert- back to the prior YTD status quo ‘risk barbell’ trade: long ‘Secular Growth’ and ‘Defensives,’ short ‘Cyclicals’—as if Thursday, Friday and Monday didn’t happen

Then again maybe not even the CPI will be a surprise: going into tomorrow's print, virtually all inflation proxies have already thrown in the towel.