The journey to tame inflation can often feel like running a marathon. And just like in a marathon, the last mile is always the hardest.
Despite this, the market’s reaction to Wednesday’s inflation print seems to suggest otherwise. The latest consumer price index data revealed a mere 3% increase over the course of a year, marking the smallest rise since March 2021. Interestingly, the Dow Jones Industrial Average saw a 2.3% boost this past week, while the S&P 500 and Nasdaq Composite experienced gains of 2.4% and 3.3% respectively. Furthermore, the two-year Treasury yield dropped to 4.7%, having previously surpassed the 5% mark.
Of course, the journey towards combating inflation has been a long one. In June 2022, annual inflation stood at a staggering 9.1%, with prices skyrocketing across almost all categories of the CPI. However, recent declines can mainly be attributed to energy prices, which have dropped by nearly 17% compared to last year. Additionally, prices of used cars and trucks have fallen by 5.2%, and airline fares, appliances, health insurance, and footwear have all become more affordable.
Nevertheless, it’s important to note that a significant factor in the decrease is simply due to inflation lapping some abnormally high months. For example, in June 2022 alone, the CPI soared by 1.2%. Therefore, when comparing it to the modest 0.2% month-over-month increase in June 2023, it results in a one percentage point reduction in the annual change.
Ultimately, taming inflation requires perseverance and strategic planning. While progress has undeniably been made, it’s crucial to remember that the last mile is often the most challenging.
The Uncertain Path to Inflation
The recent stagnation in the Consumer Price Index (CPI) in July 2022 suggests that the annual change in the index may rise significantly if inflation surpasses zero next month. According to Bianco Research, if monthly inflation maintains its pre-pandemic average during the second half of 2023, the CPI’s annual change could reach 3.9% by December, creating an illusion of accelerating inflation.
However, achieving the elusive goal of 2% inflation is expected to be challenging and potentially tumultuous for financial markets. Gregory Daco, chief economist at EY-Parthenon, points out that the advantageous trend of declining energy prices and easing food and core goods inflation is already waning. Further disinflationary momentum will now depend on slower month-over-month increases in core services prices.
Many economists believe that the next phase of disinflation will necessitate a loosening in the U.S. labor market, a task that may require a noticeably weaker overall economy. This challenge will test the resolve of the Federal Reserve to stay on its current course and could potentially weigh on stock prices.
The Federal Reserve’s rate-setting committee is scheduled to convene on July 25-26, and the futures market highly anticipates a quarter-point increase in the federal-funds rate. The following meeting on September 19-20 will have two additional months of inflation and employment data, influencing any potential changes in rates. Currently, futures market pricing does not indicate any expected rate adjustments.
Progress vs Victory
It is important to differentiate between progress and victory. While progress signifies advancement, it does not necessarily guarantee triumph. This distinction is well understood by the Federal Reserve.
In conclusion, it is crucial to recognize that progress should not be equated with victory. The Federal Reserve comprehends this distinction and acknowledges the importance of distinguishing between the two.