Financial News for the Week of October 14th, 2022

Equity markets are in positive territory on the week despite the disappointment in the September inflation data in financial news. The Fed is struggling to contain inflation, and September’s reading was hotter than expected once again. The Fed still has its work cut out for it in bringing inflation back down. However, there were a few silver linings in inflation’s gray cloud that give some reasons to believe that the fight against inflation may be turning.

First up, the bad news. Consensus expectations for a +0.2% month-over-month (m/m) reading on headline inflation were shattered by the +0.4% increase, while expectations for core inflation of 0.4% were also handily beat by the 0.6% uptick. Underpinning the rise were strong price growth in core services (+0.8% m/m), and food (+0.8% m/m). The core services print is what’s of interest as these prices are notoriously sticky. Shelter costs (+0.7% m/m), medical care services (+1.0% m/m), and transportation services (+1.9% m/m) were all well above what the Fed would like to see. Of these, the shelter component is, by far, the largest contributor to the basket and will be crucial to tempering inflation. To this end, the rate hikes are working, as evidenced by the plateau in home prices. That said, this will take time to translate into the CPI’s measure of homeowner’s equivalent rent (Chart 1), but things are moving in the right direction.

Indeed, core goods price inflation continued to moderate in September (+0.0% m/m), after having risen 0.5% in August. Helping keep a lid on things were a 1.1% m/m pull-back in used vehicles prices and a 0.3% decline in apparel prices. After the run-up over the past year, supply chain improvements are helping ease price pressures (Chart 2). These developments are important as they were always going to be among the first signs that inflation was moderating. Layer in this week’s NFIB report that showed a slightly smaller share of firms anticipating further wage gains and price increases, and the evidence for moderating inflation builds.

The Fed will welcome the signs of improvement, but if this week’s retail sales report shows anything it’s that even though things may be trending in the right direction there is still ample demand out there. The flat monthly reading registered below expectations for a modest 0.2% m/m gain but was weighed down by falling gasoline prices. The core control group (that goes into the GDP calculation) rose a solid  0.4% m/m, showing consumers are still very active.

Given that things are approaching a turning point, the Fed will be considering any weakness in the data. Indeed, FOMC member Lael Brainard highlighted that “output has decelerated more than anticipated” and emphasized the importance of “moving forward deliberately and in a data-dependent manner” amid “elevated global economic and financial uncertainty”. It would seem she is laying the groundwork for an eventual slowing in the pace of rate hikes. After 300 basis points of tightening this year, a slowing will be warranted soon in financial news. Looking forward, higher prices and diminished excess savings will help cool demand for goods and services. Coupled with improving supply-side conditions this will work to temper inflation. With other factors now starting to help the Fed in its mission, we anticipate this rate hiking cycle will top out at 4.5%.

 

Andrew Hencic, Senior Economist