The CPI data released last night was surprising. The data showed that:
CPI grew 8.5% year-over-year in July vs. 9.1% previously and below the expected 8.7%.
This article gonna answer 7 key questions:
- How to understand the importance of the declining July CPI?
- How do segments in CPI move in July?
- How did stock and futures market react yesterday?
- Will the bull market begin?
- Why traders bet on the increasing Treasury yields (important signal of recession)?
- When is the top of this rally?
- What is the long-term trend of US stock market?
⭐Tip: this article has much information and you can skip the questions you are not interested in and find the answers you are concerned about.
1. The Importance & Impacts of July CPI
The overall inflation curve looks like this:
In terms of trend, the CPI doesn't peak yet, July data is only a small retracement in the rising phase.
But it did, after all, break a small half-year streak of year-over-year increases, sending the CPI figure falling from a near 40-year high.
The biggest surprise: core CPI.
Wall Street expects that the core CPI would probably rise: from the previous 5.9% to 6.1% year-over-year.
But the core CPI growth is actually declining, with yoy growth of only 5.9%.
This is the first slowdown in growth this year.
2. A Closer Look At Segments of CPI
1) the most important contribution is the fall in energy prices.
While inflation in the services sector continues to rise, the source cost of production and living - energy prices - has seen an unexpected cooling.
Driven by falling energy prices, all consumption related to gasoline and fuel has declined, which has led to a slowdown in the core CPI
2) Housing
The cost of housing and renting continues to rise.
3) Used cars
The impact of rising houseing was offset by a small decline in used cars, as they account for a small share of the total.
We should note, however, that the weekly contraction in wages did not improve much if we go by current CPI data.
The real value of US wages has now seen 16 consecutive months of declines in the face of high CPI erosion. This figure did not improve much after the latest CPI data was released.
3. Double Reactions in Stock and Futures Markets
1) Stock Market
All three major U.S. stock indices are up 2%.
$NASDAQ(.IXIC)$, in particular, is now up 20% from its 52-week low and has re-entered a technical bull market.
2) Futures Market
Rate hike expectations have cooled sharply.
The European dollar market is down 10 basis points on interest rates by the end of the year.
The possibility of a 75bps rate hike in September-priced by federal funds rate futures-dropped from the previous 80% to 40% overnight.
4. Will the bull market begin?
I'm not optimistic about the short-term trend because the judgment of traders is divided, and the Treasury market does not seem to have changed much.
The Treasury market, which is usually the most sensitive to changes in interest rate expectations, has changed surprisingly little.
Treasuries yields fell sharply after the data was released, but then pulled up, with yields surprisingly moving higher.
And the degree of inversion between the 2-year and 10-year U.S. bonds has slowed.
Although there were shocks, the subsequent trend was smoother and not much changed from before.
5. Why are traders betting on higher Treasury yields?
The current recession expectations are not reversed judging by the extent of the 2-year and 10-year inversions.
If the U.S. bond market foretold a future U.S. recession, the increase in yields would not be due to optimism about an improving economy.
And geopolitical risk seems to have cooled. Then the higher Treasury yields should not come from supply chain concerns either.
The biggest possibility is that the U.S. bond market does not believe that this CPI data can change the pace of the Fed's rate hike.
There was also a slowdown in CPI growth a few months ago, when theories of a top in inflation were rampant.
But then the data released spiked sharply, causing the stock market to fall further.
Therefore, it is more reasonable to guess that this time the data does not change the trend of the market in the medium and long term, and inflation topping or not will be observed continuously.
Crude oil and natural gas prices will not stay in low levels for the next two months, as the US did not make progress in the Iran negotiations.
6. When is the top of this rally?
In short-and medium-term, US stocks may still peak in stages.
According to statistics, the average bear market rally is at 18%, and the current rally, too, is just within this range.
It would not be surprising if there are long-unwinding happened to $S&P 500(.SPX)$and caused market to pull back.
What's more, Musk sold his stock 3 times in nearly a year.
The first time he said he wanted to pay taxes, the second time he said he wanted to buy Twitter, and the third time, which is now, he also said he didn't have enough cash flow to buy Twitter.
Each time he sold $Tesla Motors(TSLA)$, Elon Musk successfully escaped the top.
So if Musk is right, the US stock market will pull back within one to two weeks.
7. What is the long-term trend of US stock market?
If you look at the longer-term trend, the 5-year breakeven rate is a very important figure for pricing in future inflation.
The 5-year breakeven rate has indeed seen a long-term bearish trend.
Along with the cooling of bond market bets on inflation over the next 5 years, the Bloomberg Commodity Price Index has also seen a long-term bearish move.
In summary, it is not difficult to draw this conclusion.
Consumer prices seem more likely to top in the near term than the ever higher trend in inflation.
The reason is that recession is coming!
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