Excessively sensitive equity market rallies on lower US inflation

Inflation is rolling over but what is the floor?

Nasdaq 100 futures are rallying almost 4%, the highest level since September, as the US November inflation print is showing core inflation was 0.2% m/m vs est. 0.3% m/m pushing the y/y change in core inflation to 6% vs est. 6.1% y/y. The big reaction today in equity futures in line with the previous reactions to October inflation figures indicate that the equity market is extremely sensitive to the trajectory in the inflation rate as it dictates the cost of capital going forward which is key for discounting future cash flows from companies. The rollover in inflation was never really in doubt as an excessive core inflation rate above 6% was never sustainable, but the more important question is at what level the inflation rate will normalise at. Are we going back to 2% or will it be structurally higher?

As we have pointed out in many our notes across commodities, currencies, and equities, all roads are currently leading to inflation as global supply chains are getting reshored out of China, the green transformation leads to higher energy costs, climate change will drive increasingly more supply shocks on agricultural products, China reopening its economy fueling industrial metals and energy prices, urbanisation acceleration in India, and higher military spending will all lead to higher structural inflation. The US Services inflation excluding energy that we mentioned a month ago came out at 0.44% m/m in November reducing the 6-month average of m/m changes to 0.56%, the lowest level since May, translating into 6.9% annualised inflation. This level is still way too high for the Fed for the central bank to significantly change its outlook at tomorrow’s FOMC rate decision and subsequent. As several Fed speakers have said they would like to see sustained low inflation figures before easing the policy rate.