A Mixed Bag For Inflation

A Mixed Bag For Inflation
Stéphane Renevier, CFA

about 1 year ago2 mins

What just happened?

Overall US inflation eased in December, with the consumer price index (CPI) showing a rise of 6.5%, compared to the year before. Reassuringly, it was the sixth-straight monthly decline. And the inflation was less broad-based, with only 52% of the components higher, versus 60% in November.

Core inflation – which excludes more volatile items like food and energy – rose just 5.7% from the year-earlier period, in line with expectations.

But one of the Fed’s favorite measures, core services (excluding shelter, which is lagging) stagnated at 6.4%. The measure is seen as a proxy for wage growth and many of its components rose in December. That’s not overly worrying, but it’s not a great sign either.

What does it mean?

US inflation is generally headed in the right direction – down – though as this chart shows, it might not be moving as swiftly and with as much determination as some investors – and the Fed – might like.

While it’s a mixed report, inflation is probably falling sufficiently to allow the Fed to take its aggressive hikes down a notch. In fact, that’s exactly what investors are betting on, with the market pricing in an 87% chance of a 0.25-percentage-point rise on February 1st, instead of the previously expected 0.5.

Why should you care?

The US economy is likely in a pivotal place. Inflation is going down, and that’s supportive for risk assets because it could allow the Fed to slow the pace of their hikes. The lower the interest rates, the better for assets like stocks. That’s the good news.

But there are two issues investors might be overlooking. First, inflation is largely going down because growth is slowing. Second, the Fed’s past aggressive hikes haven’t yet spread through the economy, and are likely to slow growth down further. That’s the bad news.

So while investors seem to be focusing on falling inflation rather than falling growth now, there’s a point at which this might change. Should growth start to fall at a faster pace than inflation, the main narrative might shift from softer interest rate hikes to higher recession risks. So try not to be drawn in by falling inflation, and think about the growth picture too if you’re considering buying risk assets.



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