Market Celebrates Easing Inflation
Headline inflation rose +0.4% m/m during October, coming in below the +0.6% m/m consensus estimate. While October's increase was the same as September, the underlying data indicates price pressures are easing. Prices increased for Food (+0.6% m/m), New Vehicles (+0.4% m/m), and Transportation Services (+0.8% m/m), but at a slower pace. In addition, prices for Apparel (-0.7% m/m) and Used Vehicles (-2.4% m/m) continued to decline. The big surprise – sharp price reversals in Medical Care Services (-0.6% m/m) and Utility Gas Services (-4.6% m/m).
The initial takeaway – the worst inflation pressures could have passed. The Fed's aggressive rate hikes may be starting to work as intended, with structural inflationary drivers caused by the pandemic improving. As an example, we attribute the Medical Care Services decline to rebounding Health Care employment balancing the labor market and easing wage pressures. In addition, the continued Apparel and Used Vehicle price declines point to outright deflation due to overstocked inventories and normalizing demand. Easing inflation is a positive development, and markets wasted no time lowering the terminal rate.
However, the economy may not be in the clear quite yet. Why? The Fed has already raised interest rates +3.75% since mid-March and is expected to raise rates again during December and early 2023. Pivoting or slowing interest rate hikes now may not stop the macro trends already in motion. Companies could continue to layoff employees and find ways to cut costs, mortgage rates near 7% will continue to restrict housing activity, and capital (i.e., equity and debt) will remain both difficult to find and expensive. In other words, easing inflation may put a floor under the market due to a lower terminal rate and lower Treasury yields, but it may not be enough to reverse current macro trends because monetary policy has a lagging effect on the economy. In the meantime, the market appears to be trying once again to forecast a "Fed pivot."
Time will tell. It is not yet clear if inflation has definitively peaked or not. Future publications of inflation data, along with GDP and employment data will continue to reveal the state of the economy. In the meantime, we continue to focus on the long-term. We are investing today for intermediate to long-term outcomes, so the precise timing of when inflation peaks is not terribly impactful. Thorough planning, thoughtful positioning, and the process of systematic execution will have a greater effect on accomplishing investor goals.
