More Evidence of Inflation’s Demise
Posted on November 16, 2023 in Economics
I’m sure some of you are tired of reading about inflation all the time. But I don’t exaggerate when I say that the near-term direction of inflation could potentially determine whether the stock market holds its gains for the year or abruptly gives them back. If inflation maintains its current elevated level or, even worse, reverses direction and heads higher once again, the Fed may feel compelled to remove policy accommodation more aggressively (read: raise interest rates and sell more bonds from its portfolio). And if that happens, both bond and stock investors could get spooked, leading to higher interest rates and lower asset prices.
All that said, Tuesday’s CPI report was another step in the right direction. On a year-over-year basis, headline CPI fell to 3.2% in October from 3.7% in both September and August. But more importantly, Core CPI, which excludes the volatile food and energy categories, continued a long decline to 4.0% from 4.1% in September. Both headline and core CPI were a bit better than economists were expecting.
Fed members have been fairly clear that they are most concerned about a subset of prices they call the SuperCore CPI, which consists of all services less housing and energy services and makes up about 25% of the total Consumer Price Index. Last month, the SuperCore CPI was up 0.6% on a sequential basis, which was a one-year high and would obviously be a problem if it were to be sustained (the 0.6% sequential rate times 12 months = 7.2%). As written in the October 13 Farr Market Commentary, the outsized increase in the SuperCore CPI for September was mostly due to a surge in prices for lodging away from home and transportation services, both potentially impacted by “revenge travel” following COVID. We also determined that outsized growth in car insurance rates, which are a subset of transportation services, contributed to the big bump in September SuperCore CPI. We predicted these price increases would prove transitory.
Fortunately, the outsized sequential growth in SuperCore CPI did not continue in October. In fact, the rate fell from 0.6% all the way to 0.2%. This drop is exactly what the Fed wanted to see, and therefore it is exactly why the stock and bond markets rallied so aggressively this week. Within the SuperCore figure of 0.2%, transportation services remained elevated at +0.8% due to another big increase in car insurance rates (+1.9% compared to +1.3% in September). Increases in auto insurance premiums may linger a while longer due to labor shortages, increased difficulty sourcing parts and increased driving following COVID. Prices for lodging away from home, on the other hand, fell 2.5% after rising 3.7% in September. Is “revenge travel” coming to an end? Seems like a reasonable supposition.
I continue to believe that the Fed’s concerns about incipient inflation are misplaced. The larger economic threat, in my opinion, is that high interest rates will lead to a recession, if they haven’t already. A strong labor market and high asset prices remain supportive of the economy for now, but things could change rather quickly if the Fed doesn’t soon realize that the economy will be dramatically impacted by: 1) a near tripling in mortgage rates; 2) a massive amount of expiring debt that needs to be refinanced at much higher rates; and 3) a middle-class consumer whose financial situation appears to be rapidly deteriorating.
I enjoyed the rally this week as much as anyone, but this is no time for complacency. We hope the Fed will soon recognize the powerful impact of 5.25% in interest-rate increases over such a short time span and begin to signal that no more rate hikes are being contemplated.
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