Inflation Softens: Will Interest Rates Still Rise?

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The December consumer price index (CPI) was welcome news for the stock market. Headline and core CPI numbers came in line with expectations. Headline CPI year-over-year is up 6.5% and core CPI is up 5.7%. Even though the softening inflation number was probably already priced into the market, the broader market indexes all closed higher. It’s a move in the right direction and, if this trend continues, it’s positive news for the stock market, going forward. But it’s not a done deal.

There needs to be a slowdown in rent and services, two areas that are still putting pressure on inflation. The labor market and wage growth need to cool down a lot more before inflation can come close to the 2% objective. If you pull up a chart of the headline CPI ($$CPICH), you’ll notice that it’s starting to trend lower (see chart 1). And that’s an assuring sign that inflation is indeed cooling.

CHART 1: CHAINED CONSUMER PRICE INDEX ($$CPICH). The upward trend in the headline CPI is starting to turn lower. Chart source: StockCharts.com. For illustrative purposes only.

Are Investors Becoming More Complacent?

Another area to watch is volatility. The CBOE Volatility Index ($VIX) seems to be finding a new home below the 20 level. If it stays around this level or goes even lower to pre-pandemic levels, it could be a sign that investors are getting more complacent. But that would mean that investors would gravitate towards risk-on investments, Yet gold is trading higher. Does that mean investors are still uncertain and want to tread carefully? Perhaps, given that earnings season kicks off with four large banks—JP Morgan Chase (JPM), Wells Fargo Bank (WFC), Citigroup (C), and Bank of America (BAC).

Banks set the stage for the earnings season, since their results provide an overarching view of the state of the economy. That’s enough to make investors a tad bit nervous.

Loans are a big driving force behind bank earnings. If you want a mortgage or a car loan, you have to go to your bank to get one. Higher interest rates help banks earn greater profits on loans. It’ll be interesting to see how much the higher rates helped. You also get a look at trading activity that took place during the last quarter; given the volatility in the market last quarter, there’s a chance that trading activity increased. Another important theme to listen for from the bank reports is the state of business and consumer credit. It’s a great indicator for gaining insight into business and consumer activity, two big economic driving forces.

Recession or Soft Landing?

The Fed will make its next interest rate decision on February 1. Hopefully, Jay Powell and his team look at the December CPI number favorably. But it’s just one data point. A further hike in interest rates is likely, at least for the next few meetings, but the rate at which interest rates are hiked may slow down. The CME FedWatch Tool shows over a 90% probability the Fed will raise interest rates by 25 basis points. That would be an indication that inflation is cooling, which could mean a soft landing. If the Fed decides to raise rates by 50 basis points, there could be some wild swings in the market. A lot depends on the labor market and services. When both these start to cool, it could be an indication that the Fed is in the home stretch of its interest rate hike.

The Stock Market is Optimistic

It was nice to see the Nasdaq Composite ($COMPQ) get a boost, closing just a hair above 11,000. Besides being a round number, this level holds some significance. If you look back on the daily chart of $COMPQ (see chart 2), on December 15, 2022, you’ll see there’s a gap down in value to the 11,000 level. If $COMPQ continues higher, the gap would be filled and the index could move up to the 11,500 level. The other side of the coin is that the 11,000 level could act as a resistance level and $COMPQ could fall back down toward the 10,200 level.

CHART 2: NASDAQ COMPOSITE AT CRITICAL LEVEL. Will it break above 11,000 and fill its December 15 gap down or will it bounce off the level and move lower? Something to keep an eye on in the coming days. Chart source: StockChartsACP. For illustrative purposes only.

Investors Are Still Cautious

Positive news is great, especially after a super volatile market at the end of 2022. But anything can happen during earnings season. So, tread carefully, keep an eye on your technical indicators, and make risk management a priority.


Jayanthi Gopalakrishnan

Director, Site Content

StockCharts.com

 

 

Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.

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