The Market Overreacts to Inflation Data That Barely Changed

Last week, CPI inflation was released and surpassed economists’ forecasts by 0.2 percentage points as inflation came in at 2.1 percent for January.

As a result, market panic ensued, with the Dow Jones falling over 500 points and the S&P 500 falling around 43 points in a matter of minutes before reversing back to positive territory later in the day. Was the initial panic really justified by the data? We dove into the data to find out what changed from December and January.

Using CPI inflation data from the Bureau of Labor Statistics, headline inflation was driven, once again, by services (excluding energy), contributing 1.5 percentage points in December and January. Commodities (excluding food and energy) also contributed the same in January as it did in December, dragging by 0.1 percentage points. Core inflation, which omits food and energy prices, also didn’t budge from the previous month, coming in at 1.8 percent. Core prices actually fell 0.42 percentage points in 2017, which we discussed in our previous post .

Looking closer at the more volatile food and energy prices, those too remained nearly the same. Aggregate food prices didn’t change from December to January, contributing 0.2 percentage points in both months, while energy prices moved just slightly in January, but in the opposite direction. In December, energy contributed 0.5 percentage points, falling by 0.1 percentage points in January. As a result, headline inflation in January remained the same as it was in December – 2.1 percent.

Exhibit 1. CPI inflation (unadjusted) and sub-categories, author calculations. Source: Bureau of Labor Statistics

Bond yields, which often fluctuate when inflation data releases, spiked this morning. The yield on the US’ 10-year Treasury bill remained flat during the overnight hours, staying roughly in the 2.81 to 2.83 range. However, as news broke about inflation surpassing expectations, the 10-year rose 4 basis points in a matter of minutes, from 2.82 to 2.86. The bond market, however, remains skittish, with the 10-year Treasury yield reaching 2.91 at the time of market close.

Related: Will Higher Corporate Profits Boost Investment Spending via Tax Reform?

The market movement last week was likely a rapid, initial reaction to the data. Even though the data surpassed estimates, there is limited concern that inflation will spike. The equity market has cooled on such concerns, with the S&P ending up 1.34 percent and the Dow up 1.03 percent.