Inflation Still Receding for Now, but Uncertainty Abounds

Interest rates have reversed an initial decline following the release of the Consumer Price Index (CPI) for October yesterday.  The widely followed gauge of consumer prices was essentially in line with expectations, both on a headline basis and after removing the volatile categories of food and energy.  However, if we dig a little deeper into the numbers, it appears that price increases for non-shelter services are still running a little hot. The so-called “Super-Core” CPI, which only includes services but excludes shelter, came in at an uncomfortably high 4.4% for the month – a notch above the 4.3% reported for September and still well above the Fed’s inflation target of 2%. Should we be concerned, then, about an imminent resurgence in inflation?

Probably not anytime soon. The categories driving the outsized growth in services prices have not changed for the past several months, and they are still highly likely to come down in the not-too-distant future. Most notably, prices for transportation services grew at a nosebleed 8.2% pace in October, continuing a long string of outsized increases. Within the category, vehicle maintenance & repair prices rose 5.8% and vehicle insurance prices rose a whopping 14.0%. These increases represent a delayed response to the surge in new and used auto prices that occurred during 2021 and 2022 but has long since relented. In fact, prices for new and used vehicles are down more than 1% since the end of 2022. This stabilization will eventually show up in the costs to service, repair and insure vehicles.

Another services category that has seen higher rates of inflation in recent months is medical care. In the chart below, you will see that medical care inflation increased to nearly 4% in October (blue line). However, recent increases are more related to difficult comparisons as medical care inflation fell for the better part of 2023. If we instead look at two-year growth rates, depicted by the orange line, the cost of medical care actually is running closer to 1% annually. 

What’s my personal read on the inflation data? I think that the disinflationary trend remains intact and that the recent increase in interest rates is reflective of factors other than the incoming inflation data. I wouldn’t go so far as to say that investors have completely discounted a near-term resurgence in inflation, but it seems to me that inflation concerns are now taking a back seat to concerns about the new administration’s policies and its impact on inflation and economic growth. Investors are starting to conclude that continued interest rate cuts and expansionary fiscal policy (like the tax cuts that are expected to be coming from the new administration) may indeed boost growth in the near term. However, the longer-term outlook for inflation also has probably increased as well owing to other policies coming from the new administration, such as tariffs and greater restrictions on immigration. In other words, the business of forecasting interest rates has gotten significantly more complicated than just interpreting the monthly CPI reports.

Nobody knows how all of this will play out.  At a minimum, investors are optimistic about the new administration’s ability to strike the right balance of policy prescriptions. At worst, investors have become highly complacent. I wouldn’t be so foolish as to offer a guess as to which camp is right. But one of the most basic investing truisms is that investors hate uncertainty. Despite the uneventful passing of the election, policy uncertainty, at least, has only increased. The breather that stocks appear to be taking this week could be just that. Or it could reflect a paradigm shift to a world of increased uncertainty. Periods of political change always require adjustment and recalculation of near-term positions and strategy. Longer term trends prevail over time despite the short-term uncertainty and volatility. Keep your eye on the horizon, ignore the temporary noise, and please call us if we can be helpful.