BofA Warns Stocks Underpricing Risk of Inflation Return

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BofA Warns Stocks Underpricing Risk of Inflation Return

stock :: 2024-12-11 :: source - bloomberg

By Michael Msika and Jan-Patrick Barnert

(Bloomberg) -- While the fight against inflation may largely have been won, tensions over price pressures could still disrupt confidence about interest-rate cuts. The stock market seems to be looking past these warnings.

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Equities have flourished in the favorable “Goldilocks” conditions of a resilient economy, falling inflation and rate cuts. Yet there are worrying signs in price movements, while reflationary expansionist fiscal policies could pose a risk to the easing cycle. Tariffs under Donald Trump’s administration threaten to bump up inflation projections for next year. For the moment, all eyes are on Wednesday’s US consumer price index figures.

Investors appear sanguine in the hours leading up to the print, with options on the S&P 500 index implying a move of 45 basis points. That’s lower than the average realized move of 71 basis points over the past year, according to Bloomberg calculations. December S&P 500 futures were 0.1% higher as of 7:30 a.m. New York time.

“The market is underpricing CPI risk,” said Bank of America Corp. derivatives strategists including Gonzalo Asis. “We believe CPI matters more this time.”

The strategists note that the market has under-reacted on CPI days since February, with more focus instead on the growth outlook. Yet, worries about the economy have moderated, while the November inflation surprise data climbed by the biggest margin since May.

That has set up inflation readings and central bank meetings as this month’s biggest risk events. A cooler CPI print today can clear the path for a late December rally, in what’s typically the second-strongest period in the year for stocks. A hotter print could revive volatility, the BofA team says.

A surprise in inflation to the upside could prove a problem because stocks are showing some vulnerability to a shock, following the latest market moves and positioning by traders.

Flows from options dealers setting up hedging positions have acted as a market stabilizer in recent weeks. This so-called long gamma meant dealers had to buy if the market moved lower and sell if it moved higher, which reduced the potential for high volatility.

With the S&P Index’s latest decline — US stocks have dropped for two sessions — the benchmark lost part of its downside gamma buffer, according to option specialists at Tier 1 Alpha. “The 6050 strike is now the last meaningful pocket of positive gamma before we venture into that no man’s land around the gamma flip point,” they wrote, referring to S&P 500 levels. The index closed near 6,035 points on Tuesday.

Since flirting with the 6100 level last Friday, the S&P 500 has dropped nearly 1%, while the US 10-year Treasury yield rose to its highest level in nearly two weeks.

The annual US inflation gauge remains above target and is expected to tick up to 2.7%. Investors have already identified accelerating global price pressures as the biggest tail risk to equities, according to BofA’s November fund managers survey, with 32% picking this worry above geopolitics at 21%. While the market may have stumbled a bit earlier this week, the mood among investors remains outright bullish.

A JPMorgan Chase & Co. Market Intelligence team led by Andrew Tyler has laid out scenarios for market reaction ahead of Wednesday’s data release. Looking at the month-on-month CPI, they see a 65% chance that the figure will be an increase of between 0.25% and 0.35%, which would imply gains for the S&P 500 between of 0.25% and 1%.

The team sees a 30% chance of a print between 0.35% and 0.4%, which could send the benchmark down 0.5%. In the unlikely scenario that the figure exceeds 0.4%, the S&P 500 could fall by as much as 2.5%, they wrote.

--With assistance from Christian Dass.

(Updates to add S&P 500 performance since Friday in 10th paragraph. An earlier version corrected to clarify November inflation surprise data climbed most since May in fifth paragraph.)