Beware The Bounce If October CPI Comes In Soft

By Tatiana Darie, Bloomberg Markets Live analyst and leveraged finance reporter

A cooling in inflation on Thursday could very well set off a relief rally in the stock market. Just don’t expect it to stick around for long because it’s unlikely that the Federal Reserve will be diverted from its rate-hiking path, even if it slows the pace in December.

It’s been a recipe for disappointment to get bullish ahead of CPI reports this year, despite various positive signals. Out of the 10 readings in 2022, only one came in lower than expected (July) while two others met estimates (Dec, Feb). This time, though, it feels a bit different, with several indicators offering reasons for optimism, as my colleague John Authers laid out here. At last, economists expect underlying inflation to have cooled in October even as the headline number probably rose on a monthly basis.

Markets look more poised for a low print than a high one, although the meltdown in crypto caused some rebalancing in the positioning. This year’s precedents aren’t on long-only traders’ side either: the S&P 500 has fallen on seven out of the 10 prints so far this year as they reinforced that consumer price hikes once considered transitory were far from it.

But if the numbers come in as expected or lower, that’d be undoubtedly cheered by markets for reinforcing the view that inflation is retreating steadily from its peak. Still, regardless of what the data show or stocks do, Fed policy makers have made it clear that they need lasting evidence that inflation is slowing to stop the tightening cycle. That’s what ultimately matters for equities as history shows the higher rates go, the lower multiples become.

Bloomberg Economics sees a 0.4% increase in core CPI in October from the month before, which would be a nice surprise since the consensus calls for a 0.5% rise. Still, that would be consistent with underlying inflation continuing at or above a 4% rate, too high for the Fed to let its guard down, economists led by Anna Wong wrote.

The core PCE, the Fed’s preferred measure, is also likely to print in the vicinity of core CPI and is likely tracking above the 4.5% median for 2022 in the FOMC’s latest projections, according to BEco’s Andrew Husby. These levels are far from comforting for policy makers.

Moreover, there’s another CPI release soon before the Dec. 14 FOMC decision, which may be the final arbiter. A confirmation of any trends emerging from October’s data would be required to gain more visibility on the Fed’s path.

So where does all that leave stocks? Sure, a relief in inflation can support a rebound into year-end, as JPMorgan is forecasting. Final results from the midterm election may play a role, too, although so far it isn’t playing out the way investors hoped.

But as interest rates continue to rise — even at a slower pace — and stay higher for longer, current earnings estimates and valuations may be at risk given the lagged effects of monetary policy. Margins don’t seem to have yet hit bottom.

So, as important as Thursday’s release is, investors reading too much into it are likely to face a unwanted reality check later.