More Good News on Inflation

Major stock market averages opened higher again today following yet another encouraging inflation report (see below). Bonds are trading higher as well this morning. Apparently, the bond market has been mispriced, with traders mistakenly assuming that inflation won’t subside. So now they’re reversing course, and interest rates & bond yields are falling. Over the past week the 2-year Treasury yield has retreated to 4.62% from 4.98%. According to nerwallet.com the average 30-year fixed mortgage rate is back down to 6.91%.

The Producer Price Index (PPI), which measures wholesale inflation, is in freefall. Whereas the annual rate of price growth topped 18% back in June 2022, it fell flat last month. In other words, we’re knocking on the door of deflation. PPI excluding food & energy—considered a better measure of underlying inflation—rose only 2.4% from year-ago levels. Wholesale prices are barely moving, and I suspect will now begin to fall. Goods prices were down 4.4% in June and food prices are down for the third straight month. Services prices have been more sticky but are beginning to stall as well.

A growing chorus of investors and economists are calling for the Federal Reserve to halt interest rate hikes. We pay attention to the flow of economic data, and see good reason for the Fed to declare victory over inflation. Recession is still a possibility, especially if they continue to tighten financial conditions. This morning Mary Daly, president of the San Francisco Fed, acknowledged that recent inflation data are “very positive,” but still believes “it’s really too early” to end the rate hike campaign. In other words, she’s not yet confident that inflation is firmly on track to slow to 2% because the economy still “has a lot of momentum.”

While this view is broadly consistent with other Fed officials, it seems to ignore the fact that monetary tightening has a lagged effect on the economy. And already the Fed has raised rates faster and farther than at any time in the last 40 years. In our view, it’s not too early to end rate hikes, but it is clearly too early to understand the full economic impact of what they’ve already done.