"One's a dot, two's a line, three's a trend," is how the saying goes. When applied to the inflation data this week, it spelled bad news for the financial markets.

 

Over the last two months, inflation showed increases in both the Consumer Price Index (CPI) as well as the Producer Price Index (PPI). This week, the March CPI data came in warmer than investors had hoped (0.4 percent versus expectations of 0.3 percent). The PPI was slightly below forecasts, but the monthly core index matched expectations. Not good.

 

Economists might say the jury is still out on calling a backup in the inflation rate, but traders shoot first and ask questions later. Stocks fell on the CPI release. The U.S. Treasury Ten-year bond yield breached 4.58 percent and the dollar gained more than one percent. The data squashed any hopes that the Fed would cut interest rates in June.

 

Economists were forced to take a big step back from their rosy forecasts of an imminent loosening of monetary policy. It was a far cry from January when many thought we would see as many as seven interest rate cuts by the end of this year.

 

FOMC committee members have been giving speeches and interviews over the last two weeks. Some have been sounding the alarm. Their message was clear: fewer (if any) rate cuts could be expected unless there was further progress on the inflation front.

 

To be clear, Fed Chairman Jerome Powell has not changed his tune quite yet. He still expects to cut interest rates sometime this year, but exactly when would be data dependent.

 

The bulls, however, have not given up on their rate-cut thesis. They have just pushed back the timing to July or maybe September. I must wonder whether the exact timing of this rate cut, if it occurs, really makes a big difference to the economy.  I will go a step further and question whether the Fed needs to cut interest rates at all given the growth in the economy and the strength in the labor force. By cutting rates too soon, the Fed would create what most fear — a resumption of inflation. Remember, inflation is still out there. It is only the rate of increase that has declined.

 

Some believe that the fix is in. In an election year, the incumbent usually does everything possible to boost the economy. Cutting interest rates would help the cause, so the pressure will mount for the Fed to do something soon. That seems too easy to me. I believe the Fed will do what the Fed's got to do and be damned if there is fallout from the politicians.

 

As for the markets, I have been pleased by the performance of the "catch-up" trade I had predicted at the beginning of the year. Precious metals, especially gold, have hit new highs. Silver has also performed well. Basic materials, especially copper, and some soft commodities such as coffee and cocoa have soared. Energy, Industrials, and financials have also done better than the S&P 500 Index.

 

We hit a high of 5,264 on the S&P 500 Index back on March 28 (about 20 points higher than my target) but since then the averages have drifted lower. I expect markets to continue to consolidate over the next week or so with a good chance of further pullbacks if we break 5,140 on the downside.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.