Market Meltdown
Wednesday’s CPI report triggered a market selloff, particularly hitting small caps. Both the Nasdaq-100 ETF and Nasdaq Mid-Caps ETF fell nearly 2% yesterday, while the Nasdaq Small-Caps ETF plummeted by 5.5%.
The disappointing report also led to a rise in rates, with 10-year Treasury yields climbing 15bps to 4.3%. This pushed back the expectations for the first Fed rate cut to June from May. The bigger selloff in small caps can be attributed to their higher sensitivity to rate changes due to having more floating-rate debt.
Troublesome Inflation
The disappointment in the CPI report stemmed from the fact that the headline and core inflation didn’t fall as much as expected. Headline CPI inflation slowed to 3.1% YoY, missing the market expectation of 2.9%, while core inflation remained at 3.9% YoY against an expected drop to 3.7%.
The higher-than-expected inflation was mainly driven by the housing sector which is still up 6% YoY, and core services excluding housing, which is back above 4% YoY. However, there was some positive news as core goods and Energy remained a drag on inflation.
Hopeful Signs
Despite the gloomy CPI report, leading indicators suggest that the slowdown in core services and housing inflation, which caused concern, might just be temporary.
1. Signs of Housing Relief
Zillow’s new rent inflation has hit a 2.5-year low, which could lead to a slowdown in housing inflation. Even though housing inflation didn’t decline as much as expected, the lower new rent inflation trend could have a positive effect.
2. Encouraging Labor Market Signals
The quits rate, a leading indicator of wage-driven core services inflation, has hit a three-year low, hinting at a slowdown in wage growth and core services ex-housing inflation in the near future.
Reassessing Market Reaction
Given the positive signals from leading indicators, it seems that the market may have overreacted to the January CPI data. The impending slowdown in the key drivers of inflation paints a more favorable picture than initially perceived.
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