Markets Up On Soft Landing Bets

The Dow, S&P 500 and Nasdaq all opened sharply higher this morning on what Bloomberg News calls “soft landing bets.” All eleven major market sectors are in the green. Most commodities are trading higher despite a stronger dollar. Bonds are selling off, however, as interest rate expectations rise. The narrative goes like this: recent data suggest the economy is doing just fine, that inflation may not fall back to the Fed’s 2% target anytime soon, and that interest rates will remain elevated for a while.

Inflation accelerated last month, mostly due to higher oil prices. The Consumer Price Index (CPI), a closely watched measure of retail inflation, climbed back to annual rate of 3.7% in August from 3.2% in July. Obviously, that number is moving in the wrong direction. But I’m guessing this is more of a blip than a true reversal of trend. More than half of the increase was due to a rising gasoline prices (by 10%!).

Core CPI, which excludes volatile categories like food & energy, tells a different story. Underlying retail prices ticked up a relatively tame 0.3% from the prior month, and the annual rate fell to 4.3% from 4.7%. This number is going the right direction, and there is reason to believe Core CPI will continue to moderate in coming months. For example, we know that the estimated cost of housing is a large part of this index, and in fact was the single biggest contributor to last month’s increase. We also know that CPI calculates housing costs with a huge time lag. So CPI cost of shelter is still rising at a 7.3% annual rate, whereas Zillow says rent inflation in the US is currently at 3.2%. The point is, the rate of change should continue to slow.

This report probably won’t prompt the Federal Reserve to raise interest rates again, but it will encourage them to keep rates elevated for a while. Why? First, 4.3% inflation is still a ways from the official target of 2%, and the Fed is paranoid about it reaccelerating. Second, the fact that Core CPI is still above 4% suggests that the economy is still healthy. In other words, maybe we can handle restrictive rates for a while.

US retail sales—mostly covering goods rather than services—rose .6% in August from the prior month (and 2.5% from a year ago). A good portion of last month’s gain was due to higher gasoline prices, which is not necessarily a good thing. Sales excluding gas showed modest .2% growth. There is some evidence that consumers forced to spend more on necessities are cutting back on discretionary items like sporting goods and furniture. Clearly, significantly higher credit card rates should dampen spending somewhat. That said, household finances and spending remain pretty resilient. And other reports confirm that spending on services is stronger than for goods.

So the takeaway for investors is that things are holding together for now. We still have a decent chance of a soft landing—that is, knocking down inflation without triggering a serious recession.