Inflation Moderates but Pressures Persist
Last week the biggest news was the CPI (or Consumer Price Index). The headline CPI came in above consensus as energy costs came in higher with a year over year rate of 3.7%. The Core CPI which takes out the more volatile food and energy components was right on consensus with a year over year rate of 4.15%.
Complicating Factors Remain
While the Core CPI is still in a downward trend at 4.15%, it is still twice the level that the Fed has indicated as a target level. Inflation is slowing but not by much, especially when looking at core components. Some expect prices to keep moving higher, with oil prices likely rising as conflict and OPEC cuts continue. These are a big component in most goods and services, so prices will likely keep rising.
Fed Policy Outlook
This would indicate the Fed’s work is not yet done, but the general decline in core CPI is welcome. We anticipate a pause in a rate hike for the November 1st Fed meeting, as interest rate traders put the odds below 5%. Higher long-term rates might do some of the Fed’s work for them.
The PPI (Producer Price Index) was also mixed with both the headline PPI and core PPI both having inched upward, but remaining close to 2%.
However, the monthly real (inflation adjusted) average hourly earnings was negative for the second month in a row at -0.18% which pulled down the year over year reading at 0.46%. The problem with falling real average hourly wages is the sense of treading water for many workers and how that might impact consumption. If real wage growth stays at zero or negative for too long, then longer-term decisions such as home ownership, small business formation, and job creation can also be affected.
Global Economic Considerations
While a general decline in the Core CPI is welcome, there are two complicating factors. With conflict in the Middle East, we might see both Russia and Saudi Arabia use oil as a weapon, which would have an inflationary effect here in the US. Depending on the expectation of duration, the Fed might raise rates even more as they work to contain inflation.
Global growth is being revised lower and expected to continue this trend in 2024. China is already stimulating their economy again. At this time, we still expect the US economy to go through a mild recession in 2024, but the US is still showing a stronger economic picture than most of the developed world.
Given the current fixed income rates and expectation of a recession next year, we are moving out onto the longer end of the yield curve to take advantage of higher long-term rates and the price appreciation that comes from future expected rate cuts. Equities do face some pressure given the relative value of fixed income rates in regard to the expected return on equities. Also, in the nearer term, earnings face pressure from increases in costs and potential demand weakness. Finally, consumption may also drop as money finds its way towards the higher rates.
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