Peak Inflation Confirmed!

Major stock market indexes jumped this morning on evidence that inflation is finally moderating. At the moment, the Dow is up 470 points and the S&P 500 is up 1.8%. All eleven market sectors are in the green, led by materials, communications and consumer discretionary. The VIX fear gauge, in a shallow dive since mid-June, fell below 20. Most commodities are also trading higher except for oil, which dipped below $91/barrel. The bond market is in rally mode today, pushing interest rates lower. Perhaps a lower inflation reading encouraged investors to bet the Fed won’t have to follow through on all of its planned rate hikes.

The Consumer Price Index (CPI) confirmed inflation has peaked and is at last decelerating. July’s CPI reading held flat with the prior month and was up 8.5% from year-ago levels. That not only slower than June’s 9.1% but also lower than economists’ consensus forecast of about 8.7% y/y price growth. So-called Core CPI—excluding food & energy—also came in lower (5.9% vs. 6.1% expected). We saw a big 7.7% drop in gasoline prices during the month, and a 3.6% decline in utility prices. However, food (+10.9%) and rents (+5.7%) are still rising. So we can’t declare victory over inflation yet.

The New York Fed’s survey of consumers suggests inflation expectations are falling. The latest reading predicts one-year inflation at 6.2%, 3-year average at 3.2%, and 5-year average at 2.3%. That’s fairly encouraging, although it acknowledges we won’t get back down to the Fed’s 2.0% target for some time.

Last Friday’s Employment Situation Report was a blowout with US payrolls surging over 500,000 during the month of July. The economy has now recovered all of the jobs lost during the pandemic. The unemployment rate (3.5%) is also back to pre-Covid levels. But it’s not quite that simple and tidy. From then to now about 600,000 people left the workforce and aren’t measured by the unemployment rate. We still miss them of course as the economy grapples with insufficient numbers of waiters, flight attendants, truck drivers, etc. So despite slower economic growth and fears of recession, companies are obviously still hiring. There are a couple of different ways to view this situation. It is my sense that investors are clinging to the narrative that more jobs means sustained inflation which means more Fed interest rate hikes that will ultimately kill the economic cycle. In other words, investors would be more comfortable with less hiring and a rising unemployment rate. I don’t necessary agree with that. Economists tell us that inflation would be lower if the supply of labor weren’t constrained. In other words, more hiring lures people back into the labor force which could ultimately help reduce inflation.