Stocks Surge on Calm Core CPI - But Why?

Posted by urbandigs

Fri Jun 15th, 2007 09:41 AM

A: This is the disconnect between the stock markets and the real world that makes equity trading so mysterious. When I saw the inflation numbers come out this morning at 8:30, I saw a surge in consumer inflation. But when you strip out the volatile food and energy components, the Core CPI rose only 0.1% as reported on CNBC. Stock futures surged as this was below expectations of a rise of 0.2%; giving a bullish knee-jerk reaction to the equity markets and a fall in yields. But when you look a bit deeper, it's not all rosy. Here's why.

First, the news. According to Yahoo Finance's article titled, "Consumer Prices Shoot Higher in May":

Consumer Prices Shoot Up at Fastest Pace in 20 Months in May, Fueled by Surge in Gas Prices. So far this year, consumer prices have been rising at an annual rate of 5.5 percent, double the 2.5 percent increase for all of 2006. The acceleration has occurred because of the surge in energy costs and increases in food costs that have been caused in part by higher demand for ethanol fuel, which is produced with corn.
The same article then goes into the Core CPI number, which is a closely monitored dataset of our Fed board of governors, you know, those guys that set monetary policy. The article stated:
Outside of the volatile energy and food categories, inflation rose by a much more modest 0.1 percent. That was slightly lower than the 0.2 percent which had been expected and provided reassurance that this year's surge in energy costs has not spread to other parts of the economy.
Sounds great right! Well just hold on a minute. There is one VERY important REAL statistic you should consider when looking deeper into this Core CPI number that was the catalyst for this morning's surge in stock futures and will probably lead to a very bullish day on wall street:

  • The ACTUAL Core CPI # was 0.14978486% and was rounded DOWN to 0.1% leading to a number that BEAT the consensus estimate of a rise of 0.2%. Another .001% of a percent and this number would have been ROUNDED UP to 0.2%, and in-line with expectations which would have caused a more muted reaction in stock futures and bond yields. Hmmm.


    • Furthermore, add in this interpretation of one aspect of the Core CPI reading that housing costs remained at the same level and you see that rental price decreases outside Manhattan helped keep inflation lower than what it might normally be.

  • Housings Costs (40% of the Core CPI #) rose only 0.1% and reflected the continued decline in nation wide rental prices (not Manhattan mind you). As unsold inventory gets converted to rentals, prices have been declining for renters in many markets providing some relief in these inflation datasets. I talked about this a while ago in my post titled, "Inflation & Condo Conversions", where I stated:
    So, rental prices are considered a good portion of the CPI data used to monitor inflation. This is important because with nationwide housing inventory at very high levels contributing to the weak housing market outside of New York City, there is a growing trend of converting condo inventory into rentals...As rental inventory increases across the rest of the nation prices should ease, helping to further moderate the CPI data that eventually comes out!
    Now, while the fed looks more closely at Core CPI, stripping out food & energy volatility, the real world IS affected by these inflationary items. Honestly, who doesn't buy food or fill up their car with gas? So, don't look too much into this so called tame Core CPI reading today. But by all means enjoy and ride the stock market reaction to it! Why not right?

    As far as I'm concerned, global commodity prices are hitting peak highs, oil prices are nearing $70/barrel, consumer inflation did soar, core-cpi barely missed being rounded up to meet expectations and not beat expectations as it did, global economies are very strong, US economy seems stronger than expected, corporate profits are beating estimates, and rates should still be rising globally!

    Not much has changed on the inflation front when you look into it with clear eyes!

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