CPI Preview: "Optimism For A Low Print"

If May was a month that brought us that much closer to the Fed's "soft landing" soft landing, where jobs slumped and CPI came slightly below estimates (as we predicted), June has been a mirror image with last week's payrolls report coming in red hot (if one can claim that a 600K+ drop in full-time jobs is a red hot), and so all eyes will be on tomorrow's CPI print at 8:30am ET for the tie breaking vote, not least of all because it will come just hours before the Fed's 2pm ET decision (as a reminder, FOMC members already have the CPI report in hand, and are encouraged to update their forecasts up until mid/late morning). In other words, the CPI print will be very important.

What does Wall Street expect?

• Headline CPI is expected to rise just 0.1% MoM in May, down from 0.3% in April thanks to a drop in gas/oil prices, with the range of analyst forecasts between just 0.1-0.2%.  The Y/Y is expected to maintain the prior month's pace at 3.4%, with forecasts between 3.3-3.5%.
• Core CPI is expected to match April's 0.3% pace, with analyst forecasts ranging between 0.1-0.3%. The Y/Y is expected at 3.5%, down from the 3.6% in April, with forecasts between 3.4-3.6%.

• It's worth noting that there is a bimodal distribution for tomorrow's core CPI with most economists (57 out of 69) expecting a 0.3% print with just 12 economists slotting in a 0.2% forecast, and nobody forecasting a 0.4% MoM increase. Needless to say, a below-estimate 0.1% core CPI print - distinctly possible if OER comes in very weak - and we are off to the races and probably a July rate cut.

After a string of hot inflation reports in Q1 when all core CPI reads came in stronger than expected, last month's, April CPI, was the first to show some inflation progress return in 2024, something that Fed officials have acknowledged, but caveated they are not there yet. Fed's Waller noted in the wake of the data that it suggests progress towards the 2% target has likely resumed, but he admitted the progress was modest. This data will be used to help confirm if that progress is continuing, and at what pace, or perhaps stalling, or even reversing.

The hot inflation reports at the start of the year questioned whether the Fed has done enough to return inflation to target. The Fed largely toed the line that they will keep rates at the current "restrictive" level for a longer period of time, and that further rate hikes were not the base case. Nonetheless, some had opted to leave the options of rate hikes on the table in case inflation reaccelerated. Ahead of last week, money markets were fully pricing in two 25bp rate cuts from this year, however, the hot May NFP report saw these expectations ease with now just one rate cut fully priced. The CPI data will help either cement market expectations for one rate cut, or if it comes in on the soft side it will likely see markets start to price in two rate cuts with more conviction.

The data will also have implications for the FOMC rate decision due later on Wednesday (previewed earlier), which also releases its updated Dot Plots. Fed Chair Powell in December noted that "participants are allowed to, encouraged to update their SEP forecast until probably midmorning today", therefore some may revise their dot plots on the day of the FOMC after they see the CPI data.

Turning to the specifics of the report, in their CPI preview note (available to pro subscribers in the usual place) Goldman's economists expect a 0.25% increase in May core CPI (vs. 0.3% consensus), corresponding to a year-over-year rate of 3.50% (same as 3.5% consensus). The forecast is consistent with a 0.20% increase in CPI core services excluding rent and owners’ equivalent rent and with a 0.19% increase in core PCE in May.

Goldman highlights three key component-level trends it expects to see in this month’s report.

• Slower pace of inflation in consumer electronics, personal care, and other consumer products, reflecting price declines in the Adobe dataset and consistent with price cuts announced by large retailers.

Car insurance prices will keep rising but the pace of increases will slow: Goldman forecasts a 1% increase in the car insurance component, compared to 1.8% in April and 2.6% in March.

• Rent and OER inflation will remain stable at 0.35% and 0.42%, respectively, reflecting a normalization in the pace of new-tenant rent growth and a larger gap between new- and existing-tenant rents among single-family units, which are weighted more heavily in OER, than in the overall rental market. Going forward, Goldman believes that stronger rent growth for single-family homes will likely lead OER to continue to outpace rent in the CPI, and expects overall shelter inflation to be running at a monthly pace of around 0.34% by December 2024 (reflecting a 0.26% pace for rent and a 0.37% pace for OER), implying a year-over-year rate of 4.9%.

Elsewhere in the report, Goldman expects a 3% pullback in airfares, reflecting lower jet fuel prices and declining prices in its real-time measure of airfares. The bank also expects a 1.1% increase in used car prices, reflecting higher auction prices in May

Going forward, Goldman expects monthly core CPI inflation remain in the 0.2-0.3% range for the next few months before settling around 0.2% by end-2024. The bankers see further disinflation in the pipeline in 2024 from rebalancing in the auto, housing rental, and labor markets, though expect offsets from catch-up inflation in healthcare and car insurance and from single-family rent growth continuing to outpace multifamily rent growth. Goldman forecasts year-over-year core CPI inflation of 3.5% and core PCE inflation of 2.8% in December 2024.

In terms of the market’s reaction function, Goldman trader Lee Coppersmith is out with a note (also available to pro subs) in which he makes the following market reaction prediction:

The straddle-implied move for tomorrow is 1.00, up modestly from last month's expectation of a 0.95% move and notably higher from the January's 0.70% move on CPI day; this is also the highest since November, but generally on the low side over the past two years.

Looking at some additional thoughts from around the Goldman trading desk, the consensus is “cautiously optimistic” even as the bank likes "replacing equity length with call spreads"

• Dom Wilson (Senior Markets Advisor): The combo of a CPI release and an FOMC with a fresh SEP is obviously a key event risk and creates the potential for a decent amount of intra-day movement too. Our baseline forecasts (0.25% on core CPI with an eye into a 0.19% on core PCE and a 2-cut median dot for 2024) are likely to be a source of at least modest relief, and the news since the May FOMC suggests that Chair Powell should not sound too different from the last press conference. The market is still worried about the extent of progress on the inflation side and I think there are plenty of people expecting a 1-cut Fed dot, so avoiding those more hawkish outcomes should deliver some upside to risk assets. You’ve also got a somewhat higher vol profile for the day than in some prior months, which suggests more focus/nervousness on these events. I think you need a core inflation reading above 0.3% to create a real challenge, and a 1-cut 2024 dot – even though it won’t really be unexpected - would probably also create some renewed upward pressure on yields and downside for equities. Our core view has remained positive on US stocks, while using cheaper optionality to protect against event risk, so the basic strategy hasn’t changed. There isn’t as clear an opportunity here as we sometimes see, but I think the current set-up favors calls or call spreads. With very near-dated vol elevated it may make sense to avoid very short-dated tenors, which have often looked particularly attractive for these events. And we’ve also started to think about more medium-term protection opportunities as the US election comes more firmly into focus. I think part of the challenge is that the calendar beyond here doesn’t create an obvious runway for extended relief, particularly with European political noise picking up. You’ve also got the BOJ behind this and beyond that the focus turning to the first Presidential debate - we’ve generally liked using the recent weakening in the USD to set up some medium-term long USD exposure for the coming month, though the European election surprises have meant that entry points in spot and vol are not nearly as good as last week.
  
• Joe Clyne (US Index Vol Trading): Heading into FOMC/CPI, short-dated vols have retraced back towards the lows of the year (excluding the very end of May). S&P 1 month 25 delta call vols are trading on a single digit vol handle which is more than a vol below its one year average. Interestingly, we are still seeing substantial vol inversion between June and July with the rich event calendar over the next few days. The combination of the vol inversion, the low vol further out the curve, and the substantial dealer long gamma positioning leads to us liking long vol trades better than long gamma trades over the course of this week. The straddle for CPI/FOMC itself looks to go out around 1% which certainly isn’t egregious, but you would need both events to surprise in the same direction to substantially outrealize that straddle. In the short-dated space, we like SPY July call spreads to play for further upside and, in the belly of the curve, we think 4 month SPY vol is the most attractive area to go outright long vol as it approaches post-2017 lows.
  
• Shawn Tuteja (Macro EQ Vol Trading): Our sense from client conversations is that there is optimism for a low CPI print, and we think that's helped provide support for broader equities (excluding RTY / cyclicals / banks) on this most recent leg higher in bond yields. We’re watching as to whether clients use a low CPI print as a way to reduce overall portfolio risk. GS PB shows nets in the 99th percentile now on a 1y lookback (70th on a 5 year lookback), with grosses at historical highs, yet clients continue to remain constructive equities in light of a friendly FOMC committee and mixed data thus far. While much has been made of SPX implied volatility reaching new lows, this vol pressure has spilled into other assets and themes. We think there are opportunities to buy implied volatility on cyclicals and high leverage EQ names that have yet to fully price in the effects of insurance cuts coming out of the rates curve. Our view is that after the CPI/FOMC, clients will start to turn their focus to the elections, which have historically led to risk-reduction. In 2016, SPX corrected almost 9% from early Sep to end of Oct (and almost 5% over the same timeframe in 2016), and both of the previous elections have seen implied vol squeeze into them. Our internal model shows a 2.74% implied move (1.9% of which is “extra” variance) already for the election, and the first debate is on June 27th.

A quick look at JPMorgan finds the largest US bank somewhat on the hawkish side: the bank's chief economist Michael Feroli sees headline MoM CPI printing +0.2%, above the Street's 0.1%, and sees Core MoM printing +0.33%, above the Street’s +0.3% estimate (market fixings imply ~0.26% increase). On a YoY basis, he sees headline inflation of 3.4% (vs. 3.4% in previous print), aligned with the Street, and he sees core inflation of 3.6% (vs. the Street at 3.5% and 3.6% in the previous print).

JPM's market intel desk is likewise ready with its own analysis (link here for pro subs), and also looks at core CPI as the key variable to 1-day SPX moves. That said, with CPI and Fed on the same day there is a possibility of a CPI outcome being reversed by Powell’s press conference.

• Above 0.4%. The first tail-risk scenario, this outcome is likely achieved by an increase in both Core Goods and Core Services, with Core Goods flipping from deflationary to inflationary MoM. Within Core Services, we would likely see shelter inflation increase. The bond market reaction would likely be a 12-15bps increase as part of a bear flattening. Equities would react negatively to this repricing. Given the acceleration higher in inflation, rate cut bets for 2024 would evaporate and we will see the return of views of a rate hike. This would be exacerbated by any comments from Powell suggesting rates are not restrictive enough.  Probability 5%, SPX falls 1.5% to 2.5%.
• Between 0.35% - 0.40%. This outcome is likely achieved by a smaller than expected disinflationary impulse from Core Goods with Shelter remaining flat. Bonds react negatively as Sept/Nov rate cut views decrease. With market fixings pricing in ~0.26% for Core MoM, the bond market reaction could be larger than expected with many Equity investors focused on the surveyed number of 0.3%. Probability 15%, SPX falls 1% to 1.25%.
• Between 0.30% - 0.35%. This scenario has the widest range of outcomes since the low end of the range supports the disinflationary trend and the higher end of the range the stickier inflation argument. Feroli’s forecast for 0.33% would keep the YoY number flat from last month’s print. The biggest drivers are weak disinflation in shelter, increases in vehicle, medical, and communication prices. Given the move in bond yields on Friday (+14.6bps to 4.43%), there is likely a more muted response to a hotter print. Also referencing Friday, it was surprising to see stocks slough off the bond market move with the SPX falling only 11bps instead of 1%+ as we have seen over the last couple years in response to significant and sudden moves in bond yields. Probability 40%, SPX loses 0.75% to  gains 0.75%.
• Between 0.25% - 0.30%. As mentioned, the market fixing implies a 0.26% core reading and the move in yields may not be as strong as one would expect on a beat where one would expect ~15bps move in the 10Y yield but this is a positive outcome for risk assets as this print would likely restart the Goldilocks narrative with 24Q1 data being viewed as an anomaly. Probability 25%, SPX gains 0.75% to 1.25%.
• Between 0.20% - 0.25%. The immediate reaction would be a surge in September rate cut expectations with some likely pointing to July for a surprise, insurance cut given the move by the ECB. While July sees highly unlikely, putting September back on the table would be view favorably by risk assets and we could see some yield curve steepening to aid the Cyclicals/Value trade. Probability 12.5%, SPX gains 1.25% to 1.75%.
• Below 0.20%. Another tail-risk scenario, likely fueled by a material decline in shelter inflation with goods disinflation supporting the print. Look for a collapse in yields, a material increase in July cut expectations, and a rally across all risk assets ex-commodities. In Equities, this would look like an “everything rally” with both NDX and RTY outperforming the SPX. This outcome, if confirmed in the July print, would trigger a reset in thinking about which stage of the economic cycle we currently reside as well as talks of the Fed having achieved a No Landing/Soft Landing scenario. Probability 2.5%, SPX gains 1.75% to 2.50%.

We conclude with the view from JPM's market intel team, which is even more "tactilcally bullish" than the Goldman trading desk (and thus, even more opposed to the pessimism that JPM's Marko Kolanovic continues to sell week after week ever since late 2022).

• Tactically bullish. We think the 0.3% - 0.35% scenario is what unfolds. As we continue to wait for a ‘catch down’ between official housing pricing and real-time indicators, we are seeing other elements increase their inflationary impulse such as medical services and vehicle prices. This year, core prints have surprised hawkishly (3 of 5 prints) or been in line with survey (2 of 5 prints). The combination of this print with a neutral/dovish Powell press conference means that we would buy any dip created by this event. Our bullish view (at/above trend GDP + positive earnings growth + paused Fed) remains intact and the bull case gets additional support from the AI-theme which has two more data points this week in AAPL and AVGO. With 2 US holidays over the next 4 weeks, we may see volume declines lead to larger than expected moves despite an information vacuum after this week.
• Monetization menu: Tech has been the only major sectors that has outperformed on both a 1-week and 1-month basis, highlighting narrowing breadth. I think we need to see either a pullback or a shift in how the market views economic fundamentals to see market breadth return. For that to occur with this week’s events, we would need a dovish CPI print and a dovish Powell who highlights broad economic strength that is accelerating, e.g., growth without inflation. MegaCap Tech remains the “safest” long but keep an eye on Healthcare and Consumer Discretionary as other long plays if we fail to see a narrative shift. In a market broadening scenario, Energy, Financials, and Industrials are the long plays that I would add.

More in the preview folder available to pro subscribers in the usual place.