Curmi & Partners

Are markets wrong to rejoice following the recent US inflation print?

Thursday, 10th November, US stock indexes surged, the dollar slid, and Treasury yields dropped. All three major US stock indexes rebounded on the day, with the S&P 500 moving up by c. 5.5%, the Nasdaq rising c. 7.4% and the Dow Jones climbing c. 3.7%. The 10-year US Treasury fell c. 32.2 basis points, closing at 3.829%, and the 2-year US Treasury was down c. 30.2 basis points, closing at 4.326%. The US dollar index plunged c. 2.1%. The multiple big market moves were a result of what the US consumer price index (“CPI”) report did to the terminal rate expectations of the Federal Reserve (“Fed”).

The US inflation report for October stated that headline CPI rose 0.4% month-on-month, matching September’s rise and much less than the expected 0.6% month-on-month increase. Year-on-year, headline CPI for October was reported at 7.7% compared to the September result of 8.2% and the expected 8.0%. This was the first time inflation dropped below 8.0% over the last seven months, with markets taking this as strong signs that inflation is slowing.

Almost instantly, investors lowered their expectations for the terminal rate. On the day prior to the release, expectations were for the terminal rate to reach around 5.0% during 2Q2023. Following the release, expectations for the terminal rate dropped to peak at around 4.85% during the same period in 2023. This lower terminal rate would have a positive impact on the US economy and other nations. It would lower the probability of a crushing recession, while also easing pressures on other central banks to keep up with the Fed hiking pace, and in turn having a positive impact on financial markets. 

As seen several times, monthly figures can be noisy. Investors wrongly believed that inflation had plateaued over 3Q2021, and again in July of this year. Due to this belief, they adjusted their terminal rate expectations and therefore their expectations of the rate hiking pace. In both instances, they were burned as market rallies collapsed in a short time. Therefore, the question is whether this is a CPI head-fake or is this time different?

A wide range of goods seem to have moved towards disinflation. Excluding food and energy components, inflation increased 0.3% month-on-month following the September increase of 0.6%, below the expected month-on-month growth of 0.5%. Year-on-year, core inflation was below expectations of 6.5% at 6.3%, and below the prior 6.6%.

The core inflation print was driven by surging rents, as soaring mortgage rates are discouraging prospective buyers. Rent was up 0.7% month-on-month and owners’ equivalent rent (a measure of the amount homeowners would pay to rent or would earn from renting their property) was up 0.6% month-on-month. But, according to economists, these gains are slightly smaller than in September. Furthermore, private sector rent measures (which look at the market asking price of properties) have been decelerating for nearly six months. Economists interpret this as suggesting that we are past the peak month-on-month gains in this CPI measure. Excluding rents inflation, goods disinflation is broadening as supply shortages have normalised.

However, we believe that the fight against inflation is not over. There is still a problem of excess demand over supply for labour. The number of vacancies unexpectedly rose to 10.7 million in September, up from 10.2 million in August. On the other hand, the number of hires in September edged down to 6.1 million from 6.3 million in August. The level of job openings remained close to record highs seen at the end of 2021, while the number of hires has been declining since February 2022. This excess demand is underpinning inflationary pressures coming from raising wages to attract and retain staff.

“Services inflation is a sign of price pressures becoming embedded and these numbers are way too high for the Fed to take much comfort that monetary policy tightening to date has had much impact on underlying inflation,” said Fitch Ratings’ chief economist, Brian Coulton.

The reality is headline and core inflation are still well above the Fed inflation target of 2% and therefore, the Fed will continue with their rate hiking cycle. San Francisco Fed’s chief executive, Mary Daly, said “[The inflation report] is just one piece of information. It’s far from a victory … We can’t be complacent”. Furthermore, Jerome Powell said that a few more reads on good CPI are needed before the Fed can say they are done.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.