SUMMARY: Today we are watching core services ex housing CPI (CSEH). As Peter noted (HERE), core goods are responsible for most disinflation since 2022, but are primed for a bit of a rebound in 2H24. To keep inflation on a downward trajectory, disinflationary forces in core services need to increase, and service inflation is still running at too high. We look at CSEH because that is what Powell has focused on. Even if core CPI misses, if CSEH is too hot, the print won’t be dovish. And vice versa. The informed consensus puts CSEH at +0.40-0.45% m/m range. That would be ok, implying the hot CPI data last month was mostly seasonals. Easing seasonal influence in the months ahead, which consensus assumes carried over some into February, would continue to push CSEH lower.
We look at equity internals and what drives Quality, Low Vol, and the Size factors, which are tied to Momentum today, through the framework of the odds of a longer economic cycle. Hot CSEH, lowers the odds of the Cycle extending. That happens because the risk that the Fed needs to tighten financial conditions increases and recession risk increases along with tighter FCI’s. And vice versa. CSEH above +0.5% MoM will be a headwind to all things that benefit from higher odds of a longer economic cycle: Earnings Risk, small caps (particularly unprofitable small caps, check out MS22USML Index on bbg), Value, and companies with debt problems. Hot CPI would be a tailwind to Momentum, which is essentially, Low Vol, Quality, and Growth (HERE).
Peter Williams wrote us an explainer on seasonals, pasted in the full report below.
Caveats: There are two potential mitigators to a slightly hot print (there are no mitigators to a very hot print): 1) seasonals (again), and 2) the dovish employment data from Friday, which implies some softer inflation ahead. I.e. if CSEH inflation is slightly hot, but is driven by categories that economist suspect are most impacted by seasonality’s (medical care, personal care, car repair, and day care services), expect June rate cut odds to remain roughly unchanged, which means financial conditions should not change much over the coming weeks. Everyone seems to agree that seasonal impacts should be gone in March, which is why the March CPI number will be particularly important.
FYI on Financial Conditions: We wouldn’t fight the Fed’s insistence that they need to cut. But with FCI easing on the charts and implying no drag on economic output over the next year, we need to see CSEH disinflation realized. Not necessarily today, but within the next few months.
Full report below…
MARKET VIEWS: Today we will be watching core services ex housing CPI (CSEH). As Peter noted (HERE), core goods are responsible for most of the disinflation so far but are primed for a bit of a rebound in 2H24. To keep inflation on a downward trajectory, disinflationary forces are going to have to increase from core services, and service inflation is still running at too high a level. We look at CSEH because the gov’t housing data lag. Even if core CPI misses but CSEH is too hot, the print won’t be dovish. And vice versa. The informed consensus has it at +0.40%-4.5% m/m.
We look at equity internals through the framework of the odds of a longer economic cycle. Hot CSEH, lower odds, and vice versa. CSEH above +0.5% will be a headwind to all things that benefit from higher odds of a longer economic cycle: Earnings Risk, small caps, Value, and companies with debt problems. Hot CPI would be a tailwind to Momentum, which has become a lot more Quality and Growth and a lot less Value. A cool or in-line CPI reading will keep supporting the laggards and be a headwind to Mo. Within small caps, hot CPI would be a headwind to unprofitable small caps relative to profitable. FYI, we launched unprofitable and profitable small cap swaps (MS22USML Index and MS22PSML Index on bbg). Factor exposures listed below; profitable are higher Quality and Growth, and unprofitable much more risk-on. Check out the report HERE for more details.
The investors we talk to have gotten a little more concerned about financial conditions, coming off a month of hot data and some easing in FCI.
Fed officials are adamant that financial conditions are restrictive. FCI (including the Fed’s own index) do not necessarily agree with that take. We wouldn’t fight the Fed’s insistence that they need to ease. But with FCI easing on the charts, we need to see CSEH disinflation realized. Not necessarily today, but within the next few months.
There are two potential mitigators to a hot print: 1) seasonals (again) and 2) the dovish employment data from Friday, which implies some softer inflation ahead.
Peter Williams wrote us an explainer on seasonals, copied below. Seasonals will be cited particularly if the strength is driven by the same categories as last month (medical care, personal care, car repair, and day care services). We’re not saying we know they will have an impact, we are trying to prep everyone for a potential debate about seasonality, depending on the print.
Residual seasonality, which is turn of the year price increases and used to be the norm before we had 10+ years of disinflation, more directly impacts core goods than core services. But it was core services ex housing which were notably hotter in the Jan data. If this reflects annual pricing resets that incorporate higher lagged inflation, it’s likely to resolve favorably by March but could still boost Feb. The risk is that the bump is a sign of more persistent upside pressures in services. A firm core services ex housing number will mean we debate how persistent inflation trends for another month and March will be the big one. It must be resolved in March.
