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August CPI Preview & Inflation

At 8:30 a.m., the Bureau of Labor Statistics will release the August report on the Consumer Price Index (CPI). There is good reason to expect top-line inflation to be zero or negative, but don’t be fooled. There will be no reason for a victory dance or for the Fed to change course.

The key action recently has been the sharp decline in global oil and gasoline prices (shown below).

Monthly Change in Gasoline and Oil Prices

We saw the same pattern in July. Oil prices were down over 11 percent, while gasoline prices dropped over 7 percent. The result was enough to drive top-line CPI inflation to zero for the month of July. But year-over-year CPI inflation remained elevated at 8.5 percent, in part because over a full year, both oil and gasoline prices are up dramatically (see below).

Indeed, energy makes up only roughly 15 percent of the typical budget. So, despite the decline, in July the essentials – food, energy, and shelter – rose by over 11 percent year-over-year.

Year-over-Year Change in Gasoline and Oil Prices

The same will be true today in the August numbers. The top-line will be driven by the 13 percent decline in gasoline prices and 7 percent decline in oil prices. So, when the White House breaks out in its we-misused-the-Strategic-Petroleum-Reserve-and-it-worked dance, simply ignore. This is more likely just evidence that the China economy has as much life as the Patriot’s offense right now.

A better place to focus one’s attention remains shelter price inflation. Shelter constitutes one-third of the CPI; shelter price inflation has a big impact on the bottom line. More important, to date in 2022 (see below), shelter price inflation has shown no sign of peaking. The Fed will be making real progress on inflation when shelter price inflation starts moving downward in a significant and sustained manner, and not before.

Year-over-Year Change in Shelter Price

Why Is Inflation So High?

The era of ever-rising prices may be over, but high inflation will likely stick around for a while longer.

Hopes that inflation would start to decline further were dashed when the Labor Department reported that the consumer price index (CPI) rose 0.1% in August compared to July. Analysts had expected a 0.1% decline.

On an annual basis, CPI was up 8.3% in August over the prior 12 months, disappointing expectations for an 8% figure. While that’s an improvement from July’s annualized 8.5% gain, it remainsvery high.

Food prices were a sore spot in the surprisingly hot August inflation report. At the same time, the gasoline price index fell by 10.6% in the month, furthering a late summer decline.

“The cooling in the annual figure since July has tracked easing gas prices, which have been the main driver of worldwide rates of inflation that haven’t been seen for decades,” said Samuel Fuller, director of Financial Markets Online.

So-called core CPI, which strips out volatile food and energy prices, saw a bigger increase in August. Core CPI rose 0.6% over the month, and are 6.3% higher than 12 months prior.

The inflation report comes after the Federal Reserve raised interest rates to a range of 2.25%–2.5%, a dramatic increase in a short period. The stickiness of core CPI, though, will likely tell the central bank that more work is needed, especially after Fed chair Jerome Powell’s recent speech at Jackson Hole.

CPI Inflation Moderates

The headline August CPI report is the second straight month showing year-over-year inflation moderation following June’s shocking 9.1% increase.

Drivers were perhaps the main group of Americans who could have predicted the decline. The gasoline index has now enjoyed two massive monthly declines after soaring 11.2% in June. Overall, energy prices dropped 5% over the past month.

Car owners, though, shouldn’t get too comfortable. Gas prices dropped 6.1% in April this year from the month before jumping in subsequent months, and gas prices are still 26% higher than last year.

Meanwhile, the news was less cheerful when it comes to another staple: food.

The price of buying groceries and dining out surged again in August, and are now 13.5% and 8% higher than a year ago, respectively. The overall food index gained 11.4%, the biggest 12–month jump since May 1979.

Core CPI Hotter than Headline Inflation

But there’s a reason why Fed officials and economists generally look at core inflation seriously: food and energy prices tend to jump around, even if they are vital to household budgets.

The core CPI data, though, shows just how much work the Fed has to do. According to this metric, prices gained 0.6% in the month, and are 6.3% higher than last year. That’s well above the Fed’s 2% target.

Shelter was a major driver here. Housing prices grew 0.7% in August and are up by 6.2% compared to a year prior.

The latest CPI numbers come after some confusing data.

Employers added 315,000 jobs in August, while wages were up 5.2% over the past year. Still, inflation-adjusted earnings were down 2.4% over the same period, and the nation’s gross domestic product dropped for another successive quarter, which is a common, but not definitive, definition of recession.

The Commerce Department reported that the core personal consumption expenditures (PCE) price index, the Federal Reserve’s favorite inflation metric, was up 4.6% in July. Still, that’s below the February reading of 5.3%.

Inflation Remains Enemy #1 for the Fed

Inflation has been the Federal Reserve‘s enemy number one in 2022. The Federal Open Market Committee (FOMC) has made aggressive changes to U.S. monetary policy to bring inflation down to its long-term target of around 2%.

In July, the FOMC raised its target range for the federal funds rate by 75 basis points (bps) for a consecutive month.

While inflation may have peaked, prices are still rising well beyond where the Fed wants, and haven’t come down too dramatically. That’s why looks as if the Fed will raise rates by another 75 bps when the FOMC reconvenes on Sept 20-21. Market observers are expecting the Fed hikes rates by 75 bps, according to the CME Group’s FedWatch tool.

Markets are currently pricing in a 80% chance of such a hike bps rate hike, which would bring the fed funds rate to between 3% and 3.25%. The market pricing in a 20% chance for a 100 bps rate increase.

“As inflation remains elevated, the Fed will continue to raise rates to combat high inflation to bring it back to near their 2% mandate,” said Gargi Chaudhuri, Head of iShares Investment Strategy Americas.

“Currently the market is pricing in  a Fed funds rate near 4%  by early 2023. We believe that the bar is high for them to raise rates any more, given the deceleration in headline inflation that is already taking place.”

Could Inflation Help Spark a Recession?

The Fed is facing a difficult balancing act, needing to raise interest rates aggressively to bring down inflation without triggering a U.S. recession.

Rising interest rates increase borrowing costs for companies and consumers, weighing on economic activity. Up to this point, the U.S. labor market has been solid, but the S&P 500’s 13.8% year-to-date decline reflects concerns on Wall Street that the economy may not take spiking interest rates in stride.

Growth stocks are particularly sensitive to rising interest rates because fund managers typically use discounted cash flow models to determine their price targets for growth stocks. Future cash flows are considered less valuable when the discounted rate is higher.

So far in 2022, the Russell 1000 Growth Index is down 20.1%, while the Russell 1000 Value Index is down 6.4%.

Inflation isn’t necessarily bad news for every stock market sector, however. Soaring oil, natural gas and other commodity prices have helped energy sector stocks generate record profits in 2022. The Energy Select Sector SPDR Fund (XLE) is up 51% so far this year amid broad-based market weakness.

Today’s report may quash traders’ animal spirits.

“The CPI report was an unequivocal negative for equity markets,” said Matt Peron, director of research at Janus Henderson Investors. “The hotter than expected report means we will get continued pressure from Fed policy via rate hikes. It also pushes back any ‘Fed pivot’ that the markets were hopeful for in the near term.  As we have cautioned over the past months, we are not out of the woods yet and would maintain a defensive posture with equity and sector allocations.”

What’s Next?

Investors will be monitoring the Fed’s commentary on the economy at its upcoming meeting. The U.S. Bureau of Economic Analysis (BEA) will release the August PCE reading on Sept. 30. CPI and PCE measure inflation based on pricing a basket of goods.

The two baskets are different, and the formulas used to calculate each measure are not the same. The CPI calculation is based on a survey of goods consumers buy, whereas the PCE is based on a survey of goods businesses sell.

It’s important to remember today’s release is but one data point, and the Fed will digest more information before its next confab.

The Fed is trying to lower inflation without harming employment too dramatically. This report shows that it has many more miles to go.

Dollar rallies against euro, yen after surprisingly firm U.S. consumer prices

NEW YORK/LONDON, Sept 13 (Reuters) – The dollar jumped against the yen, euro and other currencies on Tuesday after stronger-than-expected U.S. inflation data, which suggested the Federal Reserve may need to stay aggressive in raising interest rates.

The dollar index , which tracks the greenback against six peers, was up 1.1% at 109.39, heading back toward last week’s two-decade peak of 110.79. The index turned positive after the data release.

The euro , pound and yen all declined, with the euro last down 1% versus the greenback to $1.0016, after hitting a nearly one-month high of $1.0198 in the previous session.

According to the Labor Department report, U.S. consumer prices unexpectedly rose in August and underlying inflation picked up amid rising costs for rents and healthcare. read more

“The data was far stronger than expected. Particularly worrisome is the fact that core inflation came in almost double estimates,” said Karl Schamotta, chief market strategist at Corpay in Toronto.

“This is going to put the idea of transitory inflation to bed for now and anchor U.S. yields and the dollar substantially higher. The key thing here is that we’re now looking at near-certain odds on a 75-basis-point move next week.”

Following the report, a price rise in interest-rate futures contracts reflected near-certainty that the Fed will at least deliver a 75-basis-point rate hike next week, with a small chance of an even bigger increase.

Dollar rallies against euro, yen after surprisingly firm U.S. consumer prices

The dollar jumped against the yen, euro and other currencies on Tuesday after stronger-than-expected U.S. inflation data, which suggested the Federal Reserve may need to stay aggressive in raising interest rates.

The dollar index , which tracks the greenback against six peers, was up 1.1% at 109.39, heading back toward last week’s two-decade peak of 110.79. The index turned positive after the data release.

The euro , pound and yen all declined, with the euro last down 1% versus the greenback to $1.0016, after hitting a nearly one-month high of $1.0198 in the previous session.

According to the Labor Department report, U.S. consumer prices unexpectedly rose in August and underlying inflation picked up amid rising costs for rents and healthcare.

“The data was far stronger than expected. Particularly worrisome is the fact that core inflation came in almost double estimates,” said Karl Schamotta, chief market strategist at Corpay in Toronto.

“This is going to put the idea of transitory inflation to bed for now and anchor U.S. yields and the dollar substantially higher. The key thing here is that we’re now looking at near-certain odds on a 75-basis-point move next week.”

Following the report, a price rise in interest-rate futures contracts reflected near-certainty that the Fed will at least deliver a 75-basis-point rate hike next week, with a small chance of an even bigger increase.

The dollar had eased in recent sessions after its strong run higher.

Against the yen, the dollar was up 0.9% at 144.095. Earlier, the Japanese currency found support from comments from officials signaling the government could take steps to counter excessive yen weakness.

The euro had been gaining in recent sessions following hawkish noises from the European Central Bank. Last week, five sources close to the matter said Europe’s benchmark rate could rise to 2% or beyond to tame inflation.

Sterling was down against the dollar as well. The pound was last down 1.2% at $1.1544. Earlier in the day, it rose to a two-week high after the British jobless rate dropped to its lowest level since 1974, while wages excluding bonuses rose by 5.2%, the highest rate since the three months to August 2021.

Sources:

https://www.americanactionforum.org/daily-dish/august-cpi-preview/

https://www.forbes.com/advisor/investing/why-is-inflation-rising-right-now/

https://www.nytimes.com/live/2022/09/13/business/inflation-cpi-report

https://economictimes.indiatimes.com/news/international/world-news/us-inflation-slips-from-40-year-peak-but-remains-high-8-5/articleshow/93481500.cms

https://www.reuters.com/markets/europe/dollar-steadies-eyes-turn-us-inflation-data-2022-09-13/

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