Inflation continues to torment capital markets

Stocks had a mixed close on Friday closing a month of losses as traders had little appetite for buying with bond yields at 2007 levels. Inflation is still high, and it ticked higher last month according to Friday’s PCE Deflator release.

The good, the bad, and the wait, what. Last week’s PCE Deflator release was an important one as the reluctant Fed is attempting to hold on to its hawk act for as long as possible. Knowing that higher rates take time to flow through the system and take full effect, and the trends pointing to lower inflation, investors are eagerly awaiting the Fed’s clear abandonment of its rate-hiking regime. However, the Fed is not rolling over so easy. This has made it easy for bond traders to wreak havoc on the treasury yield curve pushing 10-year yields to multi-year highs, causing pain for bond bulls and growth stock owners. Still, hopeful investors would be happy to see some definitive declines in inflation which would leave the Fed no choice but to announce a definitive pause in its monetary tightening. With crude oil prices on the rise, however, even the most optimistic traders knew that last month’s inflation figures, out last Friday, were not likely to be the ones to cause a pivot. And they weren’t… but they were not as bad as expected, by a slim margin. So, what did we learn?

Now, I know that the above chart of year-over-year inflation is complicated looking at first glance, but please bear with me as I walk you through it. Initially, I would like you to ignore the numerous y-axes. I could have put them all on the same axis and scale, but you would not be able to appreciate their trends, which is the key theme I want to highlight this morning. The items on the chart are just a few of the primary pain points over the past few years, namely, Food, Shelter, and Transportation. You need to eat, you need to sleep, and you need to get to work, wouldn’t you agree? Of course, you can put off buying that new 4K TV to watch your alma mater’s football team win 3 of its last four games, Europe win the Ryder cup, or Max Verstappen win another race , and. But you must pay rent, eat, and find your way to work somehow, so when prices of those are high, budget pain is more acute.

Let’s start with the price of fuel, depicted in light blue on the chart. You can see a clear spike in early 2021 when already-rising prices were accentuated by the war in Ukraine, OPEC+ supply cuts, and increased demand as commuters took back to the roads in the wake of the pandemic. However, in late 2022 fuel inflation began to abate, BUT, as you will note by the tail-end of the chart, gas prices have ticked up noticeably, largely in response to low supply. The +10.7% monthly gain in gasoline is certainly a concern and economists are watching that closely. It is worth mentioning that auto leasing which spiked to around +30% last year has come down significantly (white line in the chart) but remains uncomfortably high at +10.70%. That sky-high inflation is due to increased, post-pandemic demand on low pandemic-era supply. Some normalization there would be appreciated, but it is clear that there is much work to be done in that arena where higher interest rates should, in theory at least, have a direct impact.

Now, let’s look at food prices. My regular readers are probably tired of hearing me drone on about how inflation at the grocery store is out of hand. If you look at the green line on the above chart you will notice a pronounced decline in the trend of food prices, which is now growing at ONLY +2.90%. That is still higher than the +2% inflation target set by the Fed, but it is a positive trend, and my budget will, at some point, appreciate the softening of prices. Are you reading this, Whole Foods ?

Finally, we have shelter, and this one is of big concern to the Fed. Housing inflation is represented by the pink line on the chart above. Go on, take a quick look at it. I can wait. What do you think? Not too good, eh? We can see a steady rise and lagging peak earlier this year. Though it appears to have peaked 6 to 9 months after aggregate inflation, its recent decline from around +8% to only +7.40% is not as pronounced as the other groups, which is not great for the bigger inflation picture. You see, housing numbers are also closely tied to interest rates, theoretically, and one would expect a more pronounced decline. So, there are a few take-aways from this. If you look at the other items on the chart, you will see that they all peaked roughly 12 months ago, so if housing follows suit, we won’t see noticeable declines until Q2 of next year. The second take-away is that real estate owners are likely holding on as long as possible until financing needs to be refinanced and leases renegotiated. This is only delaying a painful repricing which will come at some point over the next 12 – 18 months. That will ultimately be great for consumers… but not so great for real estate owners. Lastly, the final take-away is that with housing costs still far too high, the Fed is likely to be inclined to keep rates higher for longer to keep the pressure on. Wait, isn’t that exactly what the Fed said it was doing?

WHAT’S GOING ON BEFORE THE BELL

Viatris Inc (VTRS) shares are higher by +2.43% in the premarket after it announced that it received an offer for its over-the-counter division. The company was formed by a merger between Mylan and Upjohn in 2020 and is known for its Viagra, Xanax, and Lipitor brands. The company is seeking to simplify its operations through the divestiture. Dividend yield: 4.86%. Potential average analyst target upside: +24.9%.

SolarEdge Technologies Inc (SEDG) shares are lower by -2.9% after the stock was downgraded to EQUAL WEIGHT by Barclays. Barclays cited continued headwinds for the company which included high inventory levels and cut its 12-month target to $152. Potential average analyst target upside: +110.2%.

FRIDAY’S MARKETS

NEXT UP

• ISM Manufacturing (Sept) is expected to have increased to 48.0 from 47.6.
• Construction Spending (August) may have gained +0.5% after climbing by +0.7% in the prior period.
• S&P Global Manufacturing PMI (Sept) is expected to come in at 48.9, in line with its earlier flash estimate.
• Fed speakers today: Powell, Harker, Williams, and Mester.
• Later in the week: JOLTS Job Openings, ADP Employment Change, Factory Orders, Durable Goods Orders, ISM Services Index, and monthly employment numbers. Download the attached economic release calendar for times and details.