Inflation Continues to Fall

Stocks sank at the open but quickly turned around. Currently, the Dow is down 170 points and the S&P is down .2%. Bonds are broadly, if slightly, lower. Commodities are at last catching a bid. After falling below $66/barrel yesterday, oil is rebounding 3%.

The yield curve has just dis-inverted. That means that for the first time in two years, the 2-year Treasury yield (3.63%) is lower than the 10-year Treasury yield (3.66%). That of course sounds rather esoteric. Why does it matter? Intuitively, we all know that short-term loans should have lower interest rates than long-term loans. But in the post-Covid era when so much in our economy has been turned upside down, this hasn’t been the case. The Federal Reserve’s fight against inflation sent short-term rates much higher. Long-term bond yields (and lending rates) didn’t spike as much because they’re not as directly tied to temporary Fed policy moves. But now, investors broadly expect the Fed to begin a rate-cutting cycle, and this is helping to reset the yield curve. It’s just another sign that the financial system is returning to normal.

Inflation continued to slow last month, though some in the news media don’t want to admit it. The Consumer Price Index (CPI) fell to an annual rate of 2.5% from 2.9% in July. Prices are down from year-ago levels on gasoline, airfare, new/used cars, furniture, appliances, computer equipment and sporting goods. Grocery & apparel prices were up less than 1%. Some services, such as legal, personal & pet care, tuition, and medical care are still seeing elevated inflation rates above 3%. And CPI’s inflation rate on rent is still stuck above 5% due what I’ll call a faulty calculation method.

It is true that Core CPI (excluding food & energy) picked up .3% from July to August, and the annual rate held steady at a 3.2%. Unfortunately, that’s what the news media is focused on this morning. Unable to see the forest for the trees, Bloomberg News says “underlying US inflation unexpectedly picked up on higher prices for housing and travel…” CNBC’s take is that investors are “nervous over high core inflation and see the Fed cutting slowly.” This is all nonsense. Core CPI excluding rent has fallen to an annual rate of 1.7%. A separate data series from the Atlanta Fed suggests core inflation excluding shelter is running at 1.5%. The Fed has won its battle against inflation.