US equity markets started the week higher, shaking off a number of macroeconomic surprises related to sticky inflation and stronger-than-expected retail sales. Markets sold off as the week progressed, as investors digested a higher-than-expected Producers’ Price Index print and St. Louis Fed President James Bullard pushed for a 50bps rate increase for the next FOMC meeting^a.  Large caps ended the week flat with the S&P 500 down 0.20% and the NASDAQ Composite up 0.63%. Small caps were the exception with the Russell 2000 higher by 1.47%.

On Tuesday the Consumer Price Index (CPI) for January showed an increase of 0.5% month over month (6.4% year over year) and an increase in core CPI of 0.4% month over month (5.6% year over year)^b. While price inflation likely peaked in mid-2022, the sticky core components (food and shelter) continue to rise and remain concerns. In particular, the shelter component was the largest contributor to inflation in January^b. Following the CPI report, Fed Funds futures increased its terminal rate expectations to 5.25% - 5.50% range, incorporating three additional 25bps hikes^c. Additionally, expectations for rate cuts later this year are beginning to decline. The key takeaway: US inflation is still too stubbornly high, which supports the Federal Reserve’s stance for continued rate increases.

The US consumer continues to show resiliency as retail sales surged 3% month over month despite rising inflationary pressures^d. The increase was broad-based with food services and drinking places rising 7.2%, leading all major categories^d. The US consumer continues to find support from a tight labor market and financial conditions have surprisingly eased to begin the year. The US economy might be reaccelerating, which could elicit a more aggressive response from the Fed.

US bond yields marched higher across the curve as the bond market continues to align itself with the Federal Reserve: the 1-year Treasury yield rose to 5%, closer to the estimated terminal rate. In sharp contrast to 2022, equity markets have appeared more comfortable with the Fed’s actions, advancing in the face of higher yields and elevated valuations.

Sources:

1. https://www.marketwatch.com/story/feds-bullard-backs-continued-rate-increases-cd59375e
2. https://www.bls.gov/news.release/pdf/cpi.pdf
3. https://www.reuters.com/markets/us/goldman-sachs-now-expects-three-more-fed-rate-hikes-2023-2023-02-17/
4. https://www.cnbc.com/2023/02/15/retail-sales-january-2023-.html