Inflation is Peaking

Stocks jumped at the open again this morning in the wake of a very welcome inflation report (see below). At the moment the Dow is up 340 points, the S&P 500 is up 1.8% and the Nasdaq is up 2.5%. The VIX Index fell to 26 and risk appetites are a little stronger today. WTI crude oil fell back to $113/barrel. The bond market is breathing a sigh of relief, thinking that perhaps the Federal Reserve won’t have to execute all of its planned rate hikes. Long-term Treasuries are up about .5% today, and corporates are up roughly .3%. As we think about the path of recovery for beaten-down stock and bond markets, a less aggressive Federal Reserve is everything.

The Bureau of Economic Analysis (BEA) published its monthly (April) analysis of consumer income, spending & inflation trends. The bottom line is that consumers continued to spend at a healthy pace, but were forced by high inflation to dip into savings. Compared with March, Incomes grew .4% and spending rose .9%. Compared with year-ago levels, incomes are up 2.6% and spending surged 9.2%. That pushed the savings rate down to 4.4%, the lowest level since 2008. All that extra pandemic stimulus cash we saved is beginning to run out, but we’re still eager to spend.

The most exciting part—if you enjoy statistics—of the report is that inflation retreated a bit. On a year-over-year basis the “PCE deflator” slowed to 6.3% from 6.6%. And Core PCE—excluding food & energy—slowed to 4.9% from 5.2%. This is a big deal because clear evidence of slower inflation will allow the Fed to forego some of its planned rate hikes. Maybe mortgage rates don’t have to go to 6%. Maybe auto loan rates don’t have to go to 10%. There are a lot of different ways to measure inflation: CPI, PPI, PCE, UIG, blah blah blah. But this one is the Fed’s preferred gauge.

The Fed’s long-run inflation target is 2%, and that’s quite a distance from the current 4.9% level. The Univ. of Michigan’s monthly survey of consumers suggests they expect inflation over the next 5-10 years to average 3%. How do we resolve that mismatch?. Are consumer expectations wrong, or will the Fed have to ultimately raise its target to 3%? We think the latter is more realistic. But that battle between 2% and 3% won’t play out any time soon. In the here and now we’re more concerned with evidence that inflation has peaked and is now slowing.