THE market had been looking for US inflation to moderate for several months.
Forward indicators of goods prices had pointed this way since Q3.
Last week the US Consumer Price Index finally delivered a much slower pace of increase than expected.
Stocks surged, which was surprising given it wasn’t entirely unexpected.
Then again, markets were looking for any relief from this year’s constant inflation woes to jump on a positive narrative.
Doers this start an ongoing trend? Or will this month’s CPI join earlier false dawns such as July?
As always with inflation the breakdown is important.
Headline was 0.4% against consensus 0.6%. Core was 0.3%, below the consensus of 0.5%.
Leading the way down was used car prices, which fell 2.4%. Leading indicators show further weakness ahead. After a Covid-led 68% rise there is plenty of room to fall.
Apparel prices fell 0.7%. Inventory overhangs in a number of retail areas may see further discounting ahead.
The surprise contributor to lower inflation was health insurance.
This had been increasing by 2% per month for the past year. It fell 4% in October — and the way it’s calculated means it will keep falling for the next year.
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Finally, rents showed some slowing in the pace of rises. They were still up 0.6%, but it was the smallest increase in six months. Again, forward indicators point to continued moderation in rent (and owner equivalent rent) in the CPI.
These changes all point to further moderation in the months ahead.
Although not entirely unexpected, lower inflation will continue to provide some encouragement to markets that the Fed can slow the pace of hikes.
December still seems a lock for a hike of 50 percentage points. But in 2023 they could moderate to 25 points or even none.
So the super-high inflation battle of 2022 may be won. But the outcome of the war is still uncertain.
Getting from 9% to 4% next year will be the easy part.
The globe is a now a different place post-pandemic.
A combination of commodity shocks from Russia and tight labour markets globally will likely see inflation get sticky around 4%. Any rate cuts by then may be wishful thinking.
Unless we tip into a steep recession the US Fed will remain wary about calling victory on inflation any time soon.
Investors should continue to view any decent rallies as an opportunity to de-risk portfolios for the challenges ahead.
Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.
Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
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