Inflation strikes again – Recovery delayed, not derailed

DEWITT, Mich. - Sept. 20, 2022 - PRLog -- Inflation remains the kryptonite of financial markets this year. Last week's hotter-than-expected consumer price index (CPI) for the month of August triggered the biggest daily decline in the S&P 500 in over two years and drove interest-rate expectations higher¹. The broad price pressures challenge the Fed to keep going and suggest that the road to the 2% target will likely be long, and could include some economic pain along the way. But there are glimmers of hope that the underlying inflation trend will likely be down in the quarters ahead. We offer the following perspective on four key questions about the recent market-moving inflation data:

What was in the August inflation report?

Despite expectations for a small monthly decline in headline inflation, the CPI surprised to the upside, rising 0.1% in August from July. The year-ago rate of inflation moderated from 8.5% to 8.3% but was still higher than the 8.1% expected. More concerning and a key focus for central banks was that the so-called core index, which excludes the volatile categories of food and energy, accelerated from 5.9% in July to 6.3%¹.

The small moderation in the headline index is welcome. Yet it is unlikely to provide much comfort about the outlook because it has been largely driven by the drop in energy prices (gasoline prices fell 10.6% in August). Price increases elsewhere remain broad. To this point, core services inflation, and shelter in particular, continue to add upward pressure. Shelter, which makes up nearly a third of the CPI weighting, increased by 0.7% from the prior month and by 6.2% from a year ago, both of which were the highest readings since the early 1990s¹. And trends in goods inflation failed to provide much help. Used car prices declined 0.1%, but new car prices rose 0.8%.

What's the outlook from here?

The persistence and breadth of inflation suggest that the road to the Fed's 2% target will be a long one. Housing inflation remains stubborn, and higher wages are putting upward pressure on other parts of services inflation. Yet, there are signs that the labor-market tightness is slowly easing, supply chains are normalizing, commodity prices are continuing to soften, and consumer demand is moderating as the Fed's rate hikes slow the economy. For these reasons, we expect the trajectory of inflation to be lower in the coming months, though not in a straight line. The August data are no doubt disappointing, but we shouldn't forget that are preceded by a downside inflation surprise in July.

Sources: 1. Bloomberg, Edward Jones