The latest numbers are in…
US inflation for July has officially cooled to 8.5%. That’s a decent reprieve from the 41-year high figure of 9.1% in June.
For investors, this is a good sign that ‘peak inflation’ may really be behind us. We will, however, have to wait and see if the monthly trend continues to be sure. Because while I’d be surprised if this data is a one-off anomaly, it is still possible.
So while we’re not out of the inflationary woods just yet, this is the first step to clearing the way.
All of which begs the question: what’s the Fed’s next move?
Powell and co may feel less inclined to resort to big hikes from here on out. I’d certainly be surprised if we saw more 75-basis-point rises in the near future. Having said that, reports from Reuters suggest they’re not going to slowdown just yet either:
‘The Fed is “far, far away from declaring victory” on inflation, Minneapolis Federal Reserve Bank President Neel Kashkari said at the Aspen Ideas Conference, despite the “welcome” news in the CPI report.
‘Kashkari said he hasn’t “seen anything that changes” the need to raise the Fed’s policy rate to 3.9% by year-end and to 4.4% by the end of 2023.’
Lagging and leading
What makes comments like these from Kashkari so peculiar is the fact that economic data is tricky.
Not only are there a whole host of different variables influencing each other, but they all operate on different time frames too.
Take inflation, for instance. It is considered a lagging indicator. This means that the data being presented is representative of a change that has already occurred in the economy — sometimes even weeks or months after the fact.
In other words, inflation data is rarely (if ever) a good metric of the current state of prices in an economy. Instead, it best serves to confirm trends and guide future policy.
This is why central banks have such a tough time trying to keep inflation in check. Because by the time they react with rate hikes, it may take further weeks or months before consequences flow into the economy.
That’s what makes this latest inflation data so important.
It is signalling that perhaps the Fed’s actions are finally starting to influence inflation.
The issue is that you then have people like Kashkari who want to keep pushing further — a move that seems motivated by a lack of understanding for this lagging effect.
After all, what the Fed should really be worried about is leading indicators such as the bond market. A yield curve inversion — which has already occurred — is often heralded as a warning of recession. Again, as Reuters reports:
‘Two hundred and twenty five basis points of rate hikes this year and the promise of more to come as the Fed battles to bring inflation somewhere in the same ZIP code as its 2% target has lifted the two-year yield almost 50 bps above the 10-year yield.
‘This is the deepest inversion since 2000, although it retreated to 40 bps on Wednesday after softer-than-expected inflation data for July.
‘According to Bank of America analysts, if the Fed’s ‘terminal rate’ ends up being more than 4% – i.e, some 50 bps higher than current market pricing suggests – then the yield curve could invert by as much as 85 bps.
‘That would be the deepest inversion since the savage Volcker-triggered recession of 1981.’
In other words, if Kashkari gets his way, the US will hurtle towards an economic calamity of historic proportions — a means of dealing with inflation that is equivalent to throwing the baby out with the bathwater.
And that’s why investors should prepare for rate cuts sooner than most think…
A return to growth
Whether it’s this year or next, all signs suggest to me that the Fed will need to start cutting rates pretty soon. They simply can’t afford to send the US into a recession, especially with ongoing geopolitical tensions between both Russia and China.
That’s why last night’s inflation figures were so important.
It is our first confirmation that the Fed may be slowing down the US economy…something that it should have started doing 12 months ago.
But I digress…
The point isn’t that they were too slow to keep inflation under control; the bigger concern is that they’ll overstep the mark trying to keep it under wraps. Because if they keep hiking throughout the remainder of 2022 and into 2023, a recession will be all but guaranteed.
No matter how idiotic the Fed may be, I can’t imagine they’ll go down that road.
All that matters is how much damage they’ll do before they realise the error of their ways…
I expect it won’t take them much convincing. After all, Powell was responsible for some of the most extreme expansionary policies the world has ever seen.
The Fed’s response to the pandemic was as swift as it was large. They practically threw cash at the market hoping it would save them from a crash.
And boy, did it work.
2020 and 2021 led to some of the biggest stock market gains we’ve ever seen — a boom to remember for growth investors.
So while I wouldn’t count on seeing a roaring market like that again anytime soon, I think we can expect growth to become a bigger focus. Not just for the US economy, but particularly for investors like yourself.
Time will tell if I’m right or wrong, but the data is certainly starting to turn.
Editor, Money Morning
Ryan is also co-editor of Exponential Stock Investor, a stock tipping newsletter that hunts down promising small-cap stocks. For information on how to subscribe and see what Ryan’s telling subscribers right now, click here.