Inflation came down in January. Why is Wall Street nervous?

Crash or land: Inflation just came down, so why is Wall Street nervous?

February 14, 2024 5:57 PM

Stocks tumbled on Feb. 13, 2024, after new inflation data was released by the Bureau of Labor Statistics.

Welcome back to "Crash or Land," Financial Planning's new column on the state of the U.S. economy. Whenever a key new data point emerges — whether it's a jobs report, inflation numbers or the latest comments from Jerome Powell — we ask wealth management's sharpest minds this question: Does it bring us closer to a recession or to a soft landing?

This week we're taking a look at an important gauge of inflation: the consumer price index (CPI). On Tuesday, the Bureau of Labor Statistics announced that in January, the year-on-year change in the CPI was 3.1%, down from 3.4% in December. Good news, right?

Wall Street didn't think so. As the new numbers were released, stocks tumbled — the S&P 500 and Dow Jones both dropped by 1.4%, and the Nasdaq fell 1.8%. The Wall Street Journal called it "the worst CPI day for stocks since 2022."

Why did investors react so negatively to a drop in inflation? The answer, in a nutshell, is the drop wasn't big enough. Many economists had been forecasting a CPI of 2.9%, and 3.1% — however slightly — fell short of those expectations.

Then there's the longer view: Since June 2023, the CPI has been stubbornly hovering between 3% and 4%. Some months it rises and some months it falls, but never by very much. So a decline of just a few decimal points doesn't represent a big change in the status quo.

Investors are eager for a change like that, because of their bottom line: They want the Federal Reserve to start slashing interest rates. And as the Fed has made abundantly clear in recent weeks, it won't do that until there's overwhelming evidence that its battle with inflation is over.

"What do we want to see? We want to see more good data," Fed Chair Powell said at his press conference last month. "It's not that we're looking for better data. We're looking for a continuation of the good data we've been seeing."

So how should wealth managers look at the latest CPI data? Is it a disappointment, or a small step in the right direction? How is the Fed likely to react? Will this delay the eagerly awaited rate cuts, or will the central bank see the new numbers as "good data"? Taken all together, does this bring us closer to crashing or landing?

Here's what the experts are saying:

Not ideal, but still good news

Jeffrey Roach, chief economist at LPL Financial

"[Yesterday's] inflation report wasn't exactly what the Fed wants to see, since services prices are still elevated and not decelerating enough to their liking. However, investors will have to wait until later this month for a more comprehensive look at consumer prices. We still expect the Fed to make its first cut in May."

Future looks bright

Brian Rose, senior U.S. economist at UBS Financial Services

"The CPI data has disrupted the string of Goldilocks growth and inflation data that had helped to lift the S&P 500 over 5,000. But it doesn't change our positive fundamental outlook for 2024 of solid growth, further disinflation and the start of Fed rate cuts in Q2 that is supportive of risk assets."

Expect a cool-off

Bret Kenwell, U.S. options investment analyst at

eToro

"In late January, Chair Powell said the Fed is unlikely to feel confident enough to cut rates in March, and with the latest inflation report, it's easy to understand why. This report reiterates that stance and most likely delays a rate cut into the second quarter.

"While a rate cut from the Fed remains a 'when,' not 'if' scenario for 2024, the assets that benefited the most from the prospects of a rate cut — like bonds, utilities, real estate and small caps — have struggled so far this year. That struggle could continue until there's more clarity on rates.

"Stocks have enjoyed a huge rally over the last few months, so it wouldn't be too surprising to see markets cool off a bit in the short term. Once we have more certainty from the Fed, investors may feel more comfortable putting their capital back to work."

Volatility ahead, but also resilience

Gene Goldman, chief investment officer at

Cetera Financial Group

"This news is just one data point and we continue to believe that disinflation is upon us. In [yesterday's] report, if you subtract out shelter costs, the CPI is up only 1.5% over the past 12 months.

"With that said, if the Fed is worried about this report, the most likely scenario would be the Fed delaying its first rate cut. If that's the case, the economy would suffer under higher rates for longer and therefore the risk of a recession increases.

"However, we feel the economy is robust enough to handle it. For example, fourth quarter U.S. GDP growth was 3.3%, well above expectations, the job market remains very strong with the unemployment rate at 3.7%, and current sectors in recession, such as manufacturing and housing, are showing clear signs of stabilizing, if not improving.

"The net effect of this inflation report is that it adds a little bit of uncertainty in terms of when the Fed first cuts rates. We still think they'll cut this summer, as they do not want to begin cutting too close to the presidential election. Until we get more clarity on inflation, the Fed's interest rate plans and corporate earnings, we expect market volatility to remain elevated."

A wake-up call

Elyse Ausenbaugh, investment strategist at JPMorgan Global Wealth Management

"The CPI January data signals that inflation is at risk of getting stuck at elevated levels if the economy and labor market don't continue to cool off. After all, we're coming off of a 3.3% GDP growth rate in the fourth quarter of 2023, and a January where you saw a very strong jobs report. One month of data doesn't change our fundamental views and the longer-term trends.

"We still see inflation continuing to cool towards the Fed's target, and expect cuts to start by the midpoint of the year, but [yesterday's] data is snapping markets out of their complacency around how quickly the rate cutting cycle might progress. …

"All in all, the data underscores why the Fed is emphasizing patience when it comes to rate cuts. The good news is that the economy at large remains resilient, and we think the precise timing of cuts to come — whether that be in May, June or July — matters less than the direction."