Anna Rathbun, Chief Investment Officer
Counting Chickens Before They Hatch
The markets have been loving the latest inflation numbers. The headline Consumer Price Index (CPI) came in last week at 7.8% YoY, finally shedding the “8-” handle and enthralling the equity markets. This week, the Producer Price Index (PPI) registered an 8% increase on a YoY basis, and the markets soared. Is there something to these data points, or is the market overreacting?
I have never seen the U.S. markets cheer over a YoY CPI of 7.8%. Yes, it is lower than last month’s 8.2%, and it is certainly lower than June 2022’s peak of 9.0%. But historically speaking, anything with a “7-” handle is still a high CPI number. The market action reminds me of former Chair of the Federal Reserve Alan Greenspan’s famous phrase, “irrational exuberance” when referring to the stock market. Also, there is a problem with the YoY figures – they are dependent on the starting point or last year’s level. So if we had a sharp price spike in October 2021, which we did, it would account for the reduction in the YoY figure.
Focusing on the current and the most recent inflationary trends, let’s take a look at the month-over-month (MoM) numbers. Unfortunately, the pace of price increases remained the same in October as it was in September at 0.4% MoM growth, so there is technically no reason for wild celebrations. In fact, in order to achieve the Fed’s target of 2% annual inflation, we would have to see a “steady state” monthly price increases of about 0.2%, or 0.17% to be exact. At 0.4% MoM rate, the latest CPI print is hardly cause for a party.
Slicing and dicing the latest CPI number further, we find that there is even less to get us excited. Food and energy prices remain elevated at 0.6% and 1.8% MoM, respectively. Rent and place of residence costs increased at a 0.7% MoM rate. Outside of these items required to maintain life and our lifestyles, the CPI on discretionary items (all items except food, shelter, and energy) fell 0.1%. Does that constitute easing inflation and therefore, is good news? Or is that more reflective of an economy that is slowing down because producers have too much inventory (yes) and are confronted by customers who have less purchasing power (yes), and now they must cut prices in order to work through their bloated inventory (yes)? That was a rhetorical question.
Prices are definitely falling in various places. We are seeing these numbers in the “goods” portion of the economy because retailers are cutting prices. Freight costs have also fallen as have commodity prices from their recent highs. But despite the dramatic rise and fall in the prices of various commodities, there is stickiness in the price increases, and that is what the Fed is worried about. Adding to the pandemic supply chain woes, the war in Europe has changed the structural profile of energy and food prices. At a 3.5% headline unemployment rate, the currently tight labor market is keeping a floor on wages. So, what drove the excitement in the markets? Embedded in the recent market movement over the inflation figures is the possibility or hope that the Fed would be less hawkish going forward. But with stickiness in prices as well as a CPI of 7.7%, I would think that inflation is still the Fed’s enemy #1. And as the Fed continues to hike into an inverted yield curve, the market exuberance may indeed be irrational.
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