Liz Looks at: Stubborn Numbers

By: Liz Young Thomas · February 15, 2024 · Reading Time: 4 minutes

Can’t Stand the Heat

It’s been a couple days since the January CPI release, but its effects linger on. Despite the year-over-year rate cooling to 3.1% in January from 3.4% in December, the story was about services inflation, and the stickiness of some important categories, such as shelter and transportation.

One of the things that has frustrated me about the inflation narrative for the last couple years is the seemingly constant rebranding of which metric is important to watch. The Federal Reserve pays more attention to PCE, yet CPI tends to grab more headlines. As the divide between the two grew — and was blamed on sticky shelter inflation (shelter accounts for 36% of CPI but only 15% of PCE) — people focused more on PCE to downplay the effect of the troublesome piece.

As a result of those pesky shelter prices, another metric called the “supercore” was introduced to the masses. The “supercore” method of measuring inflation strips out all goods and shelter; in other words, core services ex-shelter. The idea was that supercore better represented the underlying inflation trend without being influenced by the most volatile pieces. As such, if we can get supercore inflation close to the 2% target, the problem might be solved.

Aside from the conceptual issue I have with that approach (if you strip out all the problem spots, of course the number will look more like you want it to), the January CPI data proved that even the supercore method can’t hide the fact that we still have an inflation problem.

This was the ninth month in a row where the supercore hovered around or above 4% y/y, and is likely still too high for the Fed to consider cutting rates. Pre-pandemic this metric was in the 2-3% range.

Moreover, we thought we had identified all the problem areas and removed them, but this makes it clear that transportation services are another prickly piece. More specifically, motor vehicle insurance. What’s next? Supercore ex-car insurance?

Spiking a Fever

Fed funds futures were already on their way to entirely pricing out a March cut, and very quickly reduced the probability of a May cut to less than 50%. Just a few short weeks ago, markets were expecting a total of six rate cuts beginning in March. Current pricing shows four cuts not beginning until June. That was fast.

As a result, one thing that seems to have carried over from 2023 is Treasury yield volatility. After a dramatic drop in yields during Q4 (that fueled a rally in stocks), the 10-year yield has bounced back up by almost 50 basis points since late December. In reaction to Tuesday’s CPI data both 2- and 10-year yields rose by 15 bps for the day, respectively, with the intraday swing being over 20 bps at one point. Intraday moves of 20 bps or more fall in the 98th percentile since 1998.

Given that Treasurys are generally considered stable, boring, slow moving asset types, these stats are a big deal.

Still in the Kitchen

With the exception of a few days here and there, stocks have not yet shown very much fear over delaying the first rate cut, nor the persistent yield volatility. Although I do find this peculiar, the reality is that people are still buying… or at the very least, holding.

History is, of course, never perfectly replicated, but the chart below shows the long-term ranges of trailing P/Es for the corresponding 10-year yield levels. We’re currently above the mid-range of trailing P/E values for a 10-year Treasury yield between 4-6%. Although things are clearly extended by historical standards, that alone isn’t enough to drive mean reversion.

The interesting variable will be if the 10-year yield stays elevated even after the Fed starts cutting rates. Let’s assume for illustrative purposes that it falls from current levels, but remains in the 2-4% range. Forget the fact that an elevated 10-year yield would continue to constrict capital and put pressure on companies financed with debt, the historical range of trailing P/Es is considerably lower in the 2%-4% bucket.

If the theme for this cycle is “this time is different”, we also have to consider that the effects of rate cuts could also be different. Perhaps they won’t be the liquidity boon we’ve been used to since the financial crisis. If that’s the case, markets will need to do some more repricing work.


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