The weight of words – Invest.ch

Biggest drop in the US 10-year rate since the stress of early August 2024, biggest drop in the German 10-year rate since mid-June, surge of 3.7% in the Magnificent 7, one of the biggest daily increases in these last two years… scrutinizing the market reactions after the publication of American inflation for the month of December, we could legitimately expect an excellent surprise on the figures, capable of radically changing the narrative on inflation.

By Enguerrand Artaz, fund manager, and Michel Saugné, CIO

However, although there was a good surprise, it turned out to be very marginal. Total inflation was published at 2.9%, strictly in line with consensus expectations. As for underlying inflation, it came out at 3.2% compared to 3.3% anticipated – in reality, 3.248%, very close to being rounded up to 3.3%.

How then can we explain such a knee-jerk reaction on the part of the markets to such a slight surprise? This essentially relates to the extreme sensitivity of investors, particularly bond investors, which has gradually developed since the fall, in parallel with a sharp rise in interest rates. Started by the prospects of Donald Trump’s victory and the application of a program deemed inflationary, amplified by his large success in the presidential election then relayed by the restrictive tone of the Federal Reserve (Fed) at the end of its meeting from mid-December, this movement culminated with the publication at the beginning of January of a very solid report on American employment. In the meantime, investors have revised their expectations of a Fed rate cut for 2025, from 6 to less than 2. And the US 10-year rate had gone from 3.6% in mid-September to 4.8% in mid- January. A spectacular increase which reflected the return of the inflationary question to the heart of concerns.

However, if we look coldly at the inflation figures, it is difficult to detect a reason for such tension. Certainly, as it has entered its final phase, disinflation has seen its pace slow, with slightly higher price increases between August and November. However, the underlying trends, which have hardly changed, remain favorable. Housing inflation, the largest part of residual inflation but whose taking into account is very delayed over time, continues to decrease. Same observation for the main point of attention of the Fed in recent months, services excluding housing, whose price rise continues to slow down. As for the slight increase in inflation in recent months, it was mainly fueled either by structurally volatile components (airline tickets, clothing), or by occasional rebounds, notably in the prices of used vehicles, after a long phase decline. As such, inflation for the month of December, perceived as extremely positive by the markets, does not bring any change to these observations. In short, disinflation continues in the United States, a little more slowly but no less surely.

Basically, this sequence above all reflects the weight of investor psychology on the perception of economic data and, even more surely, the weight of speeches on investor psychology. This is the case of Donald Trump’s speech, of course, with the emphasis placed on the increase in customs duties, the massive expulsion of immigrant workers or even a further reduction in corporate taxes, key measures perceived as being likely to revive the inflationary dynamic. This is also the case of Jerome Powell’s speech which, at the end of the December Fed meeting, reflected the diminished confidence in the continuation of disinflation of a central bank worried about the effects of the new President’s policy. . Worried to the point of integrating them into its economic forecasts – while the vagueness persists on the measures that the new administration will adopt.

Without forgetting, finally, the recent speech by Christopher Waller, member of the Board of Governors of the Fed. Usually classified on the side of the “hawks”[1]the former vice-president of the Saint-Louis Fed made particularly accommodating remarks, considering it possible that the Federal Reserve could lower its rates up to 4 times in 2025, without excluding a rate cut at the March meeting . This amplified the easing movement on the bond markets initiated by the positive inflation surprise. A few days earlier, he had expressed confidence that disinflation would continue, and judged that the Trump administration’s tariff policy would have little effect on inflation. Given the influence of Christopher Waller within the Fed, we cannot exclude that this is a form of “after-sales service” on the part of the central bank, concerned with the level achieved and the trajectory taken by long rates in order to reconnect the markets with a form of rationality.

For the investor, this sequence serves as a reminder. The speeches of influential figures – political leaders, central bankers, etc. – and variations in market psychology create short-term volatility, from which we can seek to take advantage. In the longer term, however, economic reality – in this case, continued disinflation – generally ends up acting as a reminder force to correct excesses. Enough to help us stay the course in the face of regularly exuberant market reactions.

Editing completed on 01/17/2025

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