Inflation & Interest Rates Headed Down Together

Stocks opened mixed this morning (Dow +46 points; SPX flat; Nasdaq -.3%) without any real direction. The VIX fear gauge is up a bit to 22.6. All year this index has fluctuated between 20 and 35. In a turnabout from the last couple of months, defensive sectors like healthcare and consumer staples are leading today, whereas cyclicals like tech and materials are down the most. On the other hand, bonds are catching a bid this morning. Long-term Treasury bonds are up about 1.5%–a big move. Remember, when bonds gain in price their interest yields fall. And most lending rates are based on Treasury yields. So this two-month bond rally has pushed Bankrate’s average 30-year fixed mortgage rate back down to 6.6%.

Why are investors pushing down bond yields at the same time the Fed has pledged to continue raising interest rates? Economist Ed Yardeni says this situation indicates the Fed rate hike cycle is almost over. “That’s either because a recession is imminent or because inflation is likely to keep falling, maybe without a recession.” The point is, interest rates have already peaked for this cycle. That’s good news, but course we don’t yet know what it will cost the economy to break inflation.

Data from the Bureau of Labor Statistics confirm we’re past peak inflation. Unit labor costs rose 2.4% during the third quarter vs. economists’ consensus expectation for 3.1%. On a year-over-year basis, labor costs peaked mid-year at 7% and slowed to 5.3% since. At the same time, worker productivity improved more than expected. You won’t read many articles about unit labor costs and worker productivity, but the Fed is paying attention.