Financial News for the Week of September 16th, 2022

Hopes that the Federal Reserve can still engineer a soft landing were tested again this week in financial news. Consumer Price Index (CPI) data for August showed inflation was far hotter than expected, leading to a sharp repricing of market expectations on the future path of rate hikes. Following the release, market participants were quick to fully price a 75-basis point move from the Federal Reserve next week, and now expect the Fed funds rate to reach 4% by year-end. The pull forward in rate hike expectations triggered a sharp sell-off in U.S. equities, with the S&P 500 suffering its worst day of the year – falling by over 4%. Equities dipped a bit further through the remainder of the week and are down 5.5% at the time of writing.

In terms of the actual CPI figures, headline inflation rose 0.1% month-on-month (m/m), a few ticks above the consensus forecast. More worrying, was the 0.6% m/m increase in core inflation – a sharp acceleration from July’s 0.3% m/m gain. While some persistence in price growth across service categories such as shelter and healthcare was expected, the August data showed far more breadth and strength across nearly all goods and service categories.

While we’re hesitant to put too much stock in one month of data, the re-acceleration in goods prices is somewhat concerning. Despite demand for consumer goods cooling more recently, goods inflation has shown considerable staying power. This was reaffirmed later in the week where August retail sales data showed only a modest gain of 0.3% m/m (Chart 1). The control group of sales was even weaker, recording a flat reading on the month.

The continued gains in goods prices are even more perplexing when we consider the fact that not only is demand weakening, but inventory levels are also starting to look toppish. Inventory-to-sales ratios across department stores are now well above pre-pandemic levels – suggesting we should be seeing some disinflationary pressure (Chart 2). Other oddities are also starting to emerge across used vehicle prices. The Manheim Used Vehicle Price Index – a measure that captures dealer purchase prices – has fallen by over 10% this year, yet the CPI measure of used vehicle prices has declined by only 1.5%. This suggests that lower costs are not being passed onto consumers, and retailers are instead maintaining wider margins. Over the near-term, this is not necessarily problematic. But if left unchecked, it can start to sow the seeds of more engrained inflationary pressures. Fortunately, that hasn’t happened yet. According to data released by the New York Federal Reserve, both one-and-three-year inflation expectations have continued to move lower, with August readings falling to 5.8% (from 6.2%) and 2.8% (from 3.2%), respectively.

One piece of good news emerged this week, with a tentative agreement reached between U.S. rail companies and the unions representing the rail workers in further financial news. The labor deal averts what would have been another crippling blow to U.S. supply chains, and almost certainly lead to more near-term pressures on inflation. FOMC officials will likely breathe a sigh of relief, as the focus can remain squarely on what will still be a challenging task; threading the needle of lowering inflation while trying to avoid a recession.

 

Thomas Feltmate, Director & Senior Economist | 416-944-5730