Some Relief: On-Target Inflation Data Bring Buyers Back in After Recent Volatility

The first of this week’s three critical data releases, February’s Consumer Price Index (CPI), was pretty much in line with expectations Tuesday, perhaps easing some concerns about any possible inflation jump and Federal Reserve response.

Headline CPI rose 0.4%, in line with analysts’ consensus expectations, the government said, and equal to January’s 0.4%. Core CPI, which strips out food and energy, rose 0.5%, up from 0.4% expectations and 0.4% in January. It’s not perfect, but it doesn’t look like the kind of scary data some had feared might give the Fed little room to maneuver on its next rate decision.

Stock index futures, which had been making up ground prior to the data, added to previous gains immediately following the news.

Before the CPI release, bank stocks rebounded in overnight futures trading even as Treasury yields bounced back. This could be a sign of improved sentiment in the financial sector and a move away from the flight toward perceived safe-haven investments seen yesterday. A continuation of this trend could suggest we’re starting to see some stability return to the market.

Just in

CPI basically met expectations, though inflation certainly didn’t show signs of cooling. Prices are still up 6% from a year ago, as analysts had expected. Core CPI is up 5.5% year over year.

In the wake of the report, the probability of a 25-basis-point Fed rate hike next week climbed to 79%, according to the CME FedWatch Tool. The chances of a rate pause fell to 21%. The “pause” probability fell from 35% yesterday, possibly a sign that investors see less chance of the Fed having to shift its focus to fending off instability in the markets and away from fighting inflation.

Morning rush

• The United States 10-Year Treasury note yield (TNX) rose nearly 6 basis points to 3.57% after the CPI data.
• The U.S. Dollar Index ($DXY) retreated below 104 to a nearly one-month low of 103.67.
• The Cboe Volatility Index® (VIX) futures stepped back to 24.79, still up sharply from a week ago.
• WTI Crude Oil (/CL) fell 2% to $73.23 per barrel.

Keep an eye on the dollar index and Treasury yields today for any signs that the “flight to safety” is diminishing and stability could be returning after the last few days of volatility.

Eye on the Fed

If Wall Street’s Fed “pause” contingent gets its way, it might not be under ideal circumstances.

Over the last six months, nearly every market rally hinged on bullish hopes that the Fed might pause its rate hikes. Now, with financial stability potentially trumping inflation concerns—at least for the moment—turmoil in the financial system is likely to lead the Fed to pause and/or slow the pace of rate hikes, according to Charles Schwab (NYSE:SCHW) Chief Fixed Income Strategist Kathy Jones.

The Fed has already tightened rates enough to trigger financial stress, Jones said and could see this as a sign to back off. This could mean pausing rate hikes or ending the quantitative tightening (QT) policy it began last year, designed to slow economic growth by unwinding the Fed’s balance sheet.

For those who’d long hoped the Fed would pause rate hikes, it’s a case of being careful what you wish for. Though the Fed could still potentially hike further, it appears that any pause in the near-term wouldn’t necessarily be associated with a “soft landing” so many had wanted. Instead, it would be a response to uncertainty, which, as we know, is something markets generally shy away from. Which could help explain why falling yields and lower rate hike chances aren’t helping stocks early this week.

Think of this as a Catch-22. Bullish stock traders want the Fed to reduce rates. But lower rates—if they do come, as the Treasury market hints—could be due to economic suffering. That’s not a good scenario for stocks.

What to Watch

Producer Price Index (PPI) and Retail Sales data for February are both due this week.

PPI could provide evidence of whether price pressure has eased in the wholesale market, a key element for companies trying to protect their margins. Headline PPI and core PPI rose 0.7% and 0.5% in January, accelerating from December to their biggest gains in months.

Analysts expect:

• PPI: Up 0.3%, according to Trading Economics.
• Core PPI: Up 0.4%.

A cooler PPI outlook is often a harbinger of easier times ahead for CPI. When companies face less price pressure on the wholesale side, they can sometimes ease price growth on their customers.

This is arguably more the case now than a year ago. Consumers are exhausted by inflation, and many companies find themselves under pressure to stop raising prices, if not reduce them. A weak PPI, if we get it, would likely be welcomed by many big corporations—and by the Fed, of course.

Retail Sales

After a massive 3% month-over-month increase in January (2.3% if you strip out automobile sales), consensus for February Retail Sales growth is a huge slowdown from January at 0.3%, according to Trading Economics.

Stocks in Spotlight

Right in the middle of all these interest rate worries, home builder Lennar (NYSE:LEN) (LEN) is expected to report fiscal Q1 earnings after the close today. However, the company’s earnings conference call won’t be until Wednesday morning. The timing is actually helpful for investors trying to get a sense of the housing market as uncertainty swells.

Last time LEN reported, in December, shares fell in reaction to the firm’s forecast of slower demand amid rising mortgage rates. Shares then went on a long ride higher before losing some ground the last few weeks.

It could be interesting to watch mortgage rates this week in the wake of the rapid yield descent. First signs are potentially helpful for LEN and other builders, as the 30-year mortgage rate dropped to 6.57% Monday after recently topping 7%, according to CNBC. However, it’s still well above the 6% lows of a few weeks ago that seemed to brighten the housing picture. Also, mortgage rate moves aren’t always directly tied to Treasury market yields. If, for instance, a recession began, it could cause deterioration of household balance sheets, leading to worsening credit scores and higher mortgage rates.

Quarterly results are expected later this week from FedEx (NYSE:FDX) (FDX), Adobe (NASDAQ:ADBE) (ADBE), and Dollar General (NYSE:DG) (DG).

Pfizer’s (PFE (NYSE:PFE)) $43 billion purchase of biotech company Seagen (SGEN) yesterday was big news for the sector and for mergers and acquisitions (M&A). Health care firms are “poised for heavy deal making this year,” the Wall Street Journal observed.

Market minutes

Here’s how the major indexes performed Monday:

• The Dow Jones Industrial Average® ($DJI) fell 90 points, or 0.28%, to 31,819.
• The Nasdaq Composite® ($COMP) rose 0.45% to 11,188.
• The Russell 2000®(RUT) dropped 1.44% to 1,747.
• The S&P 500® index (SPX) fell 6 points, or 0.15%, to 3,855.

One clear thing amid so much confusion is that major indexes are having trouble holding gains. Every major index except the $COMP finished lower Monday despite early rallies even as the government reassured investors with a pledge to backstop Silicon Valley Bank (SIVB). Lack of follow-through buying, if it persists, could keep hopes for a recovery rally on the backburner.

• That said, some of the hesitance likely resulted from caution ahead of today’s CPI data and tomorrow’s PPI and Retail Sales. Investors might not want to get caught leaning one way or the other with so much at stake. Strength in so-called “mega-cap” tech stocks (see more below) helped support $COMP, and to some extent the other major indexes Monday.
• Despite assurances from the Fed and the Treasury secretary that the U.S. financial system remains on firm footing, bank-related stocks continued their retreat Monday. This included First Republic (FRC), which fell after analyst downgrades, along with Comerica (NYSE:CMA) (CMA), Fifth Third (FITB). Other financial stocks also taking a beating.
• Regional banks were hit particularly hard, perhaps because investors have less clarity on what sort of problems could be present. Smaller banks aren’t subject to the same level of government stress tests as larger ones. Regional bank pressure hurt the RUT, with its heavy exposure to that sector. The RUT’s close Monday represented a two-month low and brought it close to possible technical support near the late-December trough of 1,722. The RUT is now down 13% from its early-February peak close, compared with just a 9% drop for the $COMP (see chart below).
• Meanwhile, the food and beverage, healthcare, mining, retail, and technology sectors all delivered gains yesterday. Treasury yields extended their fall from last week, as demand from investors seeking perceived safe-haven investments pushed up bond prices.

Talking Technicals: Supposed “technical support” levels gave way last week when Wall Street grew jittery. The same thing happened three years ago during the first COVID-19 scare, as even so-called “critical” support levels like the 200-day moving average (MA) for major indexes broke down. When investors seek the exits in a major way, technical levels tend to lose some of their effectiveness. Once the dust clears, as it seemed to slightly on Monday, it could be time to check the charts on stocks and indexes you follow and see where things settled. With a big selloff, quality companies often lose ground along with more spotty ones. If fundamentals still hold up, a technical breakdown could end up being just a blip on the long-term chart.

RUT Daily Chart

CHART OF THE DAY: LEAVE ME OUT. Until recently, the Russell 2000 index (RUT—candlesticks) and the Nasdaq ($COMP—purple line) moved pretty much in sync. That changed over the last week as regional bank stocks got hurt by signs of financial instability and investors piled into mega-cap tech stocks. Data sources: FTSE Russell and Nasdaq.

Thinking cap

Ideas to mull as you trade or invest.

Bobbing: Shares of Apple (NASDAQ:AAPL) (AAPL) rose Monday after taking a southward path Friday following a downgrade from analysts at Lightshed Partners. The firm sounded bearish about iPhone and services sales trends. AAPL is an interesting stock to watch during this choppy and uncertain time. It and other mega-caps like Microsoft (NASDAQ:MSFT) (MSFT) and Alphabet (NASDAQ:GOOGL) (GOOGL) sometimes gain traction when the market is uneasy, and all three mounted decent gains Monday as the overall market weaved a choppy path. Though no stock can ever be considered a “safe” or a stable investment, these huge firms sometimes attract investors looking for stability when the rest of the market loses its footing. However, that wasn’t in evidence Friday as all three lost ground when financial industry jitters initially hit Wall Street. This mega-cap “stability” theory could wobble when you consider the current Treasury yield picture. Many investors ran toward fixed income late last week in a “flight to safety” type of trade, eschewing even large-cap stocks. Not that fixed income is “safe,” either, as many found out if they bought Treasuries last week.

Timber! Treasury yields entered full retreat Friday and Monday, with the 10-year Treasury yield falling to just above 3.5% and the 2-year Treasury yield down nearly 60 basis points on Monday to just above 4%. Both hit one-month lows after a dramatic descent, which hasn’t been seen since 1987. The yield curve inversion—where short-term yields hold a premium to long-term ones, often signaling economic pessimism—fell below 50 basis points from last week’s 100-basis-point spread. While nothing’s impossible, it’s hard to imagine yields dropping much below current levels for the moment unless more economic instability surfaces. What happened here, very quickly, is that the Treasury market repriced the interest rate picture. The market now sees the Fed raising rates this month by 25 basis points one more time, then pausing before possibly lowering rates this autumn. Just a week ago, there were heavy odds of a 50-basis-point hike and no pause in sight. If hotter than expected, this week’s inflation and Retail Sales data could rapidly reshape current less hawkish expectations, perhaps sending yields higher. But cooler-than-expected data could reinforce the Treasury market’s current rate impressions, meaning yields may not have much more room to fall.

Keep on rolling: Unfortunately (or fortunately if you appreciate dramatic market moves), the economic “rolling” process in which some pieces of the economy grow even as others contract is likely to persist in months ahead and lead to additional volatility, writes Charles Schwab Chief Global Investment Strategist Jeffrey Kleintop. While growth seems to be reviving across many major global economies and Q1 Gross Domestic Product (GDP) estimates edged higher, intermittent waves of price increases may cause investor uncertainty about the direction of economic growth and central banks’ policy response. Read more in Kleintop’s latest analysis.

Calendar

March 15: February Retail Sales and February Producer Price Index (PPI).

March 16: February Housing Starts and Building Permits and expected earnings from Dollar General (DG) and FedEx (FDX).

March 17: February Industrial Production, February Leading Indicators, and March Preliminary University of Michigan Consumer Sentiment.

March 20: No major data or earnings.

March 21: February Existing Home Sales and start of two-day FOMC meeting.

Happy trading,

Disclosure: TD Ameritrade® commentary for educational purposes only. Member SIPC. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.