Yesterday’s market rout was the result of self-deluding hope by investors that inflation would magically disappear. When it didn’t they had a hissy fit since the Fed is determined to raise interest rates until inflation is brought under control.
And the Fed will require the control period to be extended enough to be reliable. The 1970s were plagued by the Fed releasing the pressure of high interest rates, only to see inflation pop up again. Fed Chair Powell doesn’t want this on his watch.
Those who say that inflation is coming down are looking at a month-over-month reading which is mostly the result of gasoline price declines. The higher inflation is broad-based and sticky.
**Markets Keep Making the Same Mistake About Inflation**
**The danger is that stocks and bonds have further to fall because investors are still clinging to the vestiges of the belief that inflation will soon be conquered**
**By James Mackintosh, The Wall Street Journal, Sept. 14, 2022**
**Investors made a huge mistake over the summer, misreading the economy and, even worse, misreading the Federal Reserve. The scale of the mistake became obvious on Tuesday and led to the biggest one-day selloff in more than two years.**
**But the error — a belief that peak inflation will allow the Fed to ease after reaching peak rates early next year — continues to underpin bond, stock and futures prices....**
**Tuesday’s inflation figures destroyed the idea that the Fed would pause soon. Excluding volatile food and energy, prices rose 0.6%, which if sustained would be an annual rate above 7% and higher than any time from 1991 to the pandemic....**
**Investors are able to cling to their belief that the Fed will pause its rate rises early next year and begin easing again by the end of the year....Something’s up, and that something is hope....[But] Fed policy makers keep dismissing the idea that lower rates could follow quickly after a pause....** [end quote]
Here is the detailed inflation report from the BLS.
CONSUMER PRICE INDEX - AUGUST 2022
The Consumer Price Index for All Urban Consumers (CPI-U) rose 0.1 percent in August on a
seasonally adjusted basis after being unchanged in July, the U.S. Bureau of Labor
Statistics reported today. Over the last 12 months, the all items index increased 8.3
percent before seasonal adjustment.
Increases in the shelter, food, and medical care indexes were the largest of many
contributors to the broad-based monthly all items increase. These increases were mostly
offset by a 10.6-percent decline in the gasoline index. The food index continued to rise,
increasing 0.8 percent over the month as the food at home index rose 0.7 percent. The
energy index fell 5.0 percent over the month as the gasoline index declined, but the
electricity and natural gas indexes increased.
The index for all items less food and energy rose 0.6 percent in August, a larger
increase than in July. The indexes for shelter, medical care, household furnishings and
operations, new vehicles, motor vehicle insurance, and education were among those that
increased over the month. There were some indexes that declined in August, including those
for airline fares, communication, and used cars and trucks.
The all items index increased 8.3 percent for the 12 months ending August, a smaller
figure than the 8.5-percent increase for the period ending July. The all items less food
and energy index rose 6.3 percent over the last 12 months. The energy index increased 23.8
percent for the 12 months ending August, a smaller increase than the 32.9-percent increase
for the period ending July. The food index increased 11.4 percent over the last year, the
largest 12-month increase since the period ending May 1979. [end quote]
The problem is that the gasoline price is volatile. It hid inflation in other critical categories this month but could easily pop up later in the year.
Sticky Price Consumer Price Index less Food and Energy is 6%, the highest since 1990. The Sticky Price Consumer Price Index (CPI) is calculated from a subset of goods and services included in the CPI that change price relatively infrequently. Because these goods and services change price relatively infrequently, they are thought to incorporate expectations about future inflation to a greater degree than prices that change on a more frequent basis.
Young speculators who didn’t experience the 1970s inflation may think that one month of stable inflation will be enough to change the Fed’s policy. Looking more deeply into the details makes me even more convinced that I should stay defensive until the stock and bond markets gives clear signals of a bottom based on capitulation. To reduce risk, I will invest in I-Bonds and short-term Treasuries until the markets have clearly turned the corner. As I described in an earlier post.
Hope is not a reliable indicator when so much risk is at stake. At least, not to a risk-averse investor like me.