US inflation has continued to move lower. However, the core CPI remained firm with higher energy prices still to hit in coming months.
Markets initially leapt higher on the back of the better than expected drop in the headline data.
Monthly inflation fell from 0.4% to 0.1%, and to 5.0% for the year. The yearly drop was of course expected.
The real story though was in the detail of the report. While it was good to see shelter price pressures moderating, the fact that this data release only including the previous significant declines in gasoline and natural gas prices, is a major cause for concern over what may be coming next month.
We are all aware that global oil and gasoline prices are yet again on the move higher. Also, that Natural Gas looks to have bottomed and prices are rising. It is very likely much of the benefit to the lower CPI headline data just seen will be sharply reversed next month.
This is the case even if energy prices simply stay where they currently are. Should energy continue to move higher, then we could well be looking at significant re-acceleration over the coming months.
Which would shatter all forecasts of Fed rate cuts within the next year. The forecast here remains a still higher than expected by the market, terminal rate. Plus, that rates will remain on hold for a following extended period. There will be no pivot.
In fact, that unlike the IMF for instance, that rates are in fact returning to more normal historic levels permanently.
Building on the subtext concerns of yesterday’s headline data, is the fact that core CPI, the Federal Reserve’s preferred measure, remained firm at 0.4%. For the year, core CPI actually rose to 5.6%.
While the market initially felt that the headlines meant a slowing or pause of tightening soon, the core CPI actually still points to a further 2-3 rate hikes in the immediate cycle.
Energy prices on the rise
Throw in the fact that energy prices are already on the move higher, and that employment remains very strong, in the data at least, there is no room at all here for the Federal Reserve to relax in its current monetary tightening stance.
Subsequently, markets began to falter as the day progressed, and after some significant price swings, equities and bonds closed on or near their lows? Suggesting, ‘the great end of inflation euphoria rally’ may in fact be what is actually coming to an end. Or, is at least now fully priced.
That the headline data was as good as it gets in the current inflation era, and markets closed the day weakening significantly. This clearly signals that all the good news for stocks is now fully priced in.
Meanwhile, recession probabilities grow alongside their new companion of simmering bank risks. As bonds fall so too will more banks. Depositors continue to withdraw, and this will only intensify should our expected recession materialise.
The US is still faced with a sustained high inflation outlook, tighter credit and banking risk, as well as a slowing economy and further rate hikes.
The idea that a slowing economy could force rate cuts is unlikely in a still firm inflationary environment, and in any case, the associated collapse in earnings would quickly dispel any enthusiasm for broad based stock buying.
The outlook for the US economy, including stocks and property remains somewhat problematic. Even after this lower headline inflation print.
Market analysis and insights from Clifford Bennett, Chief Economist at ACY Securities
