Friday's Market Minute: Have The Markets Finally Discounted Inflation Risk?

It is hard to be a buyer of stocks as the risks of inflation and the Fed-induced slowdown of the economy continue to grow. The CPI data Wednesday was the latest in a long list of disappointing economic figures, and the result now is a coin toss between a 75 and 100-basis-points hike from the Fed in two weeks.

Core inflation now appears broadly entrenched across goods and services, which should solidify Fed officials’ confidence that restrictive policy is appropriate. The price index also showed little evidence of discounting across core goods categories, despite reports of higher inventory levels and slower real goods consumption. As a result, investors have spent much of this week puzzling over what this all means, edging up predictions for the future path of interest rates and for the chances of recession.

On the macro front, the future inflation outlook expressed by long-duration Treasury yields has dropped, which is a good sign that allegedly out-of-control inflation may finally be in decline. Two-year yields before and after the June CPI report remained well-anchored.

The reaction in the interest rate market this time was completely unlike the rapid rise before and after the May CPI report that sent the S&P on a rapid, multi-day waterfall decline that began on June 9. Since finding a tradable bottom on June 17, that broad market is higher by about 5%, with the most recent CPI report worse than last month’s print and a yield curve that has inverted once again.

With the bulk of corporate earnings reports out in the next few weeks, risk for equity bulls still remains. However, based on the market reaction before and after the CPI report this week, one might question whether the market has finally fully priced in the worst of inflation.

Afterall, stocks staged a surprisingly good recovery after the inflation data on Wednesday, with a follow-up day opening lower and closing out yesterday in the green. Not a bad reaction, considering it wasn’t too long ago that markets gravitated towards fading brief rallies on the open and closing out trading days near the lows.

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