Apr 16, 2024

The Road to Lower Inflation Takes a Detour

Weekly Market Commentary

The rate of inflation is accelerating. That’s not how we hoped to start this week’s Insights.

Take a moment and review Figure 1. The 4-month moving average has broken out of its long-term downward trend (red-dashed lines). On a monthly basis, prices bottomed in June and began to gradually turn higher. The upward trajectory picked up in January.

But, what about the so-called calendar effect? Wasn’t the bump in January and February tied to the new year? Well, apparently not.

The Consumer Price Index rose 0.4% in March. It’s up 3.5% versus one year ago. In February, it was up 3.2%.

The core rate, which excludes food and energy, rose 0.4%. It’s up 3.8% year-over-year, the same as February—see Figure 2.

Inflation has slowed dramatically on an annual basis. That is important to acknowledge. But price hikes remain elevated. Using the year-over-year rates as our yardstick, progress toward price stability (defined by the Federal Reserve as 2% annually) has stalled.

Let’s review another metric. The 3-month annualized rate can be noisier and more volatile, but it can detect new trends faster than the year-over-year rate. Like the monthly core CPI, it has also turned higher, bottoming out at 2.64% in August and rising to 4.53% in March. It has risen in six of the last seven months.

What’s happening? U.S. BLS data highlight that the price of consumer goods, excluding food and energy, are declining—yes, that’s right, declining. Goods are in a slight deflationary trend (Figure 4). But services are much higher and are showing signs of accelerating.

At best, the road to lower inflation isn’t hitting bumps; it’s taken an unexpected detour. At worst, inflation is moving higher, and we’re repeating the mistakes of the 1960s and 1970s. Or will inflation get stuck in the current range, denying the Fed the ability to start cutting rates?

Following the runup in stocks, some volatility shouldn’t be discounted. The latest CPI report is forcing a shift in sentiment on rate cuts, which is creating short-term volatility.

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A Steady-as-She-Goes Fed and a Tame Inflation Report

As expected, the Federal Reserve announced last Wednesday that it held its key rate, the fed funds rate, unchanged at 5.25 – 5.50%. The Fed left the door open to a cut in rates later in the year if inflation makes meaningful progress toward its 2% annual goal or if there is an unexpected weakening in the labor market.

Strong Jobs Report, with a Caveat

The U.S. Bureau of Labor Statistics reported that nonfarm payrolls in May rose 272,000, easily beating expectations of 190,000 per the Wall Street Journal. Over the past three years, nonfarm payrolls have usually topped expectations. That narrative remains intact.

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The price of a home hit a new record, according to the latest data on housing prices. The S&P CoreLogic Case-Shiller 20-City Home Price Index, which measures monthly housing prices in 20 major metropolitan areas, rose 1.6% on a nonseasonally adjusted basis in March.

Drifting Higher

Stocks have been drifting higher for several weeks as investors search for a catalyst that could drive shares in either direction. Interest rates can influence market direction, but there hasn’t been much news recently on the rate front.

How Do Investors Spell Relief?

Investors celebrated an ‘in line with expectations’ CPI that suggested the rate of inflation isn’t accelerating. It’s a small win, but it was enough to send the three major market indexes, the Dow, the Nasdaq, and the S&P 500 to new highs.