Stocks had a mixed close yesterday as traders played ping-pong with rate cut bets. Bank bosses threw cold water on hot-blooded bulls with warnings about growth and consumer health, even as regulators threw them a bone – making things even more confusing for investors.
What are we even talking about here. OK, it’s Consumer Price Index / CPI day. Today, we learn about how much a basket of goods grew in price last month and since last year. The latter is commonly referred to as inflation. Oh, and those prices are principally in urban settings. Do you live in an urban area? Of course, not all of you, but the Bureau of Economic Analysis will report Urban CPI this morning. Regardless of all that, it’s kind of an important event. Why? I won’t answer that. Ok, I WILL. It is because we are on the back end of an inflation mountain range which we have traversed over the past 3 or so years. Well, almost traversed.
We reached the summit in summer of 2022 when inflation topped out at +9.1%, a proportion we had not witnessed since 1981! Ya, it was that bad, but I don’t need to tell you that, because you have witnessed the painful result of it in your bank account and your confidence level. Prices are still high, but their vicious ascent has slowed. That is a colorful way of saying that inflation is normalizing. Normalizing? What is NORMAL, actually?
Well, the Federal Reserve has set an inflation target of +2%. You see, some inflation is ok, but too much inflation is… um not. We were already feeling the clear effects of inflation in the summer of 2021. Never mind what the actual CPI was, but it felt… not NORMAL. The Fed agreed but it was convinced that the spike was temporary. By the autumn of that year, the Fed realized that it was wrong about transitory inflation and started signaling to the market that it would be appropriate to raise interest rates. That didn’t happen until March of 2022 when policymakers raised rates by +25 basis points. Of course, at that point, CPI was already around 8.5%. Clearly, NOT normal. In May of 2022 panic set in at the Fed as the Bankers realized that the inflation horse had left the barn. It was time for aggressive moves, like half-percentage point or more moves. It was time to slam on the brakes… to get things back to… NORMAL. Wait, what was normal again?
That’s right, the Fed kept reminding us that, in its view at least, +2% was where inflation needed to be. It would take a total of 11 interest-rate hikes before the Fed decided to rest its guns. Its final hike was in July of 2023. Oddly enough, inflation was already clearly trending downward and well off its 2022 high, but it was still around +3%, which was still not… NORMAL. The Fed made it clear that +2% was the goal. So, we had a “ways to go” in the Fed’s own words. The Fed would use this argument to keep its hands firmly on the neck of the economy in attempts to throttle growth and ensure that inflation would get back to NORMAL, once and for all. Still, those high rates for an extended period of time started to take their toll on growth, especially in interest rate sensitive industries. Oh, and how about the stock market… AND YOUR PORTFOLIO… AND YOUR CONFIDENCE, as you watched your savings account dip in value. Ok, ok, it was a necessary bitter pill to get inflation back to… NORMAL.
Can you see a pattern emerging here? Of course, you do. I have written the word “normal” an abnormally abundant number of times. I have even taken the liberty of capitalizing the word. This morning, we will get CPI from August. Economists are expecting the annual, topline figure to come in at +2.5% after printing +2.9% in the prior period. If it does, that is really, really close to the Fed’s +2% target. Wow, we are now really getting close to… NORMAL. “Ok, Mark, enough with the NORMAL… what’s your point,” you cry! OK, ok. I took the liberty of downloading CPI going back to January of 1924. That is 1,327 observations. What do you think that the average inflation number is? Go on, guess? Would you guess +2%? If so, you would be wrong. The average is +3.28%! So, it is clear that a reading this morning of +2.5% is well within the range of… NORMAL. That is probably why the Fed is very likely not concerned with inflation at this point. BUT it is very concerned that the economy will stall. Will this morning’s CPI impact the Fed’s policy next week? It is not likely to, unless we get a real outlier. Given last week’s weak, but not horrible employment number, the Fed is likely to go with a gradual rate-cutting trajectory, especially given elections and possible policy impacts in coming months. That means +25 basis points… which is what the market is expecting. That would be normal behavior for the Fed.
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