Signs of Peaking Inflation?

Inflation – The Stock Market Achilles Heel:

The stock market is a forecasting instrument that anticipates and prices-in future economic conditions. The confluence of rising interest rates, inflation, China Covid lockdowns and the war in Ukraine has resulted in months of selling. The relentless indiscriminate selling has pushed the Dow Jones and S&P 500 deep into correction territory while pushing the Nasdaq deep into a bear market. As such, the market appears to be factoring in a worst-case scenario that may result in a Federal Reserve induced recession as a function of over-tightening on monetary policy and/or its inability to combat inflation responsibly for an economic “soft landing”.

The markets are anticipating sequential rate hikes through 2023 however, if inflation has peaked and the tightening cycle turns dovish then the markets will likely turn the tide on this relentless selling. If inflation has peaked and yields stabilize, these oversold conditions could easily reverse course. For the month of April, market conditions have not been this bad for the Nasdaq and S&P 500 since the Financial Crisis and the Covid 2020 lows, respectively. With signs of inflation peaking, the markets may have fully priced-in a worst-case scenario for an inflection point from these oversold conditions. During Federal Reserve tightening cycles, markets typically generate positive returns with an average of a 6.6% return over the tightening period (Figure 1).

Figure 1 – Market performance during periods of Federal Reserve tightening cycles.

Signs of Peaking Inflation:

There are many areas of the economy where inflation is receding or has peaked. Although energy prices remain elevated due to the Russia-Ukraine conflict, other commodities and inputs into the CPI composite that contribute to inflation are falling. There’s been pullbacks in used car sales, easing supply chains (China’s Covid lockdowns are prolonging the supply chain recovery), copper, steel, grain, soy, freight, lumber and aluminum prices.

Inflation is assessed via two means, the Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE) index. The core PCE index, removes the more volatile food and energy prices, and latest data shows the PCE is pulling back slightly.

Through 2022, the core PCE climbed 5.2% through March. That reflected a minor deceleration from the 5.3% pace seen in February. The month-over-month reading was even more encouraging of a deceleration. Core PCE rose 0.3% through March, in-line with the February pace and staying below the 0.5% increases observed in October through January.

Supply Chain Bottleneck Easing:

The persistent inflation is largely a function of supply chain issues worldwide. Shipping delays, supply shortages and production bottlenecks have yet to be resolved. This creates a supply-demand imbalance with subsequent price hikes to offset increased costs associated with these supply chain issues. Freight rates have been declining since September 2021 and seems to be in a downward trend. March also marked the third consecutive month of declines in average delays for container ships. Lower freight rates should translate into removing a major inflation pressure point.

The Consumer: