Inflation Trending Lower

Stock market indexes opened lower today but quickly turned around. Currently, the Dow is flat and the S&P 500 is up .17%. Apparently, traders are shrugging off a hot inflation report (see below). The stock market rally is nearly two months old, but many on Wall Street are calling for its demise. I suppose it’s the same with the bond market, where falling inflation (and Fed rate hike) expectations have fueled recent gains. Distrusted rallies are the best kind.

Wholesale inflation slowed in November, but unfortunately not as much as expected. The Producer Price Index (PPI) remains 7.4% higher than a year ago, and 6.2% if you strip out food & energy prices. Both of those figures are too high for the Fed’s comfort. While goods prices have essentially flat-lined, services prices are still rising despite the Fed’s efforts to slow the economy. But to be fair, PPI’s rate of acceleration has slowed steadily since March, and 7.4% is the lowest rate in 18 months. We are past the peak of inflation and the only real question is how quickly we can get back to more normal levels, say 2-3%. One year? Two years?

Surveys by the University of Michigan suggest consumers expect inflation to fall to 4.6% over next year, and average 3% over the next 5-10 years. Bond market trading gives us a different way to gauge inflation expectations. The Treasury Inflation-Protected Securities (TIPS) market is calling for a sharp deceleration in price growth—just 2.3% over the next two years. It is this hope—and faith in the Fed slowing interest rate hikes—to which investors are clinging.

We’re told that today’s trading session (and Monday’s) mean next to nothing. That’s because traders are focused on next week’s Consumer Price Index (CPI) report, as well as the Fed’s last policy meeting of the year. Those are 2022’s last two catalysts for short-term traders to crate drama and volatility.