Inflation Heats Up…But Fed Officials Stay Cool

Back when I was a young newspaper reporter, I programmed my mind to sift through ostensible dross. That’s where I’d often discover gold.

Here’s a buried nugget that leapt out at me today: Economists at the Federal Reserve Bank of Chicago wrote in a report this month that further monetary tightening probably won’t be necessary, due to 11 interest rate hikes that already have constrained inflation.

These trial balloons floated by policymakers usually go unnoticed by the hacks in the mainstream media. However, obscure news items can convey greater importance than the ratings-driven drama of cable news chyrons.

Inflation got a bit warmer in August, but Federal Reserve officials seem to be keeping a cool head. Fed Chair Jerome Powell’s most recent public comments attempted to strike a balance between vigilance and a willingness to allow previous hikes to work their way through the system.

At its meeting next week, the Fed is likely to stand pat on interest rates. According to the latest reading of the CME Group’s FedWatch tool, the consensus on Wall Street is placing the odds of a Fed pause at 97%.

Let’s closely examine the latest inflation data and what it portends for monetary policy, the economy, and financial markets.

The U.S. Bureau of Labor Statistics (BLS) reported Thursday that the producer price index (PPI) increased a seasonally adjusted 0.7% in August, higher than the 0.4% estimate and the biggest monthly gain since June 2022. However, excluding food and energy, core PPI rose 0.2%, in line with the consensus estimate.

Prices for final demand goods rose 2.0%, and the index for final demand services climbed 0.2%. Prices for final demand moved up 1.6% for the 12 months ended in August (see chart).

Separate reports also released Thursday confirmed the slightly inflationary trend. The Commerce Department reported that retail sales rose a higher-than-expected 0.6% in August, above the 0.1% estimate. Most of the sales increase was due to higher gas prices. Excluding sales at gasoline stations, retail spending advanced a more modest 0.2% in August from July.

The Labor Department reported that Initial jobless claims nudged up to 220,000 for the week ended September 9, below the 225,000 estimate. The four-week average of jobless claims dropped to its lowest level in seven months.

On Wednesday, the BLS reported that the “core” consumer price index (CPI), excluding the volatile food and energy components, rose 4.3% year-over-year, in line with the estimate and down from 4.7% in July. On a monthly basis, core CPI rose 0.3% versus the 0.2% estimate.

This batch of data collectively depicts moderating inflation, without a recession. Investors are heartened by this “Goldilocks” scenario.

The main U.S. stock market indices closed higher on Thursday, as follows:

  • DJIA: +0.96%
  • S&P 500: +0.84%
  • NASDAQ: +0.81%
  • Russell 2000: +1.40%

Small stocks and cyclicals were among the leading performers, which is a sign of economic optimism.

The successful initial public offering of chipmaker Arm Holdings (NSDQ: ARM), which is 90% owned by SoftBank Group (OTC: SFTBY), buoyed the tech sector and fueled overall bullishness. The CBOE Volatility Index (VIX) fell more than 5% to close below 13, signaling less fear in the markets.

The S&P 500 currently hovers well above its 50- and 200-day moving averages, which shows positive momentum.

Markets are forward looking, and Wall Street already is looking beyond the tightening cycle to more sanguine conditions in 2024. We’re seeing a diminished likelihood of nasty inflation surprises and the era of rising rates is winding down.

The European Central Bank (ECB) on Thursday hiked its key interest rate to a record high, but ECB officials also hinted that this latest increase would be the last.

Several mega-trends, notably artificial intelligence and renewable energy, are forming the foundation for a future secular bull market. However, we’ll first have to endure the seasonal downdraft of September-October.

WATCH THIS VIDEO: Momentum Hits a Rough Patch

To be sure, I still see red flags. The benchmark 10-year Treasury yield has ticked higher to around 4.28%. The 4.3% yield threshold is the crucial inflection point to watch. A move higher would signal that bond traders are increasingly worried about inflation.

Additional risks emanate from the kindergarten along the Potomac, aka Congress.

Lawmakers are gearing up for yet another budget fight, with ultra-conservatives in the GOP-controlled House vowing to shut down the federal government unless their demands for deep spending cuts are met. The White House and Senate, both in Democratic hands, refuse to back down. And so…once again…we face market-roiling brinkmanship over the budget.

At the same time, the House has launched a long-shot impeachment probe into President Biden, even though GOP leaders in the Senate say the effort lacks evidence and will probably boomerang to hurt Republicans at the polls in 2024.

This political feuding doesn’t inspire confidence that our lawmakers will get anything meaningful accomplished during the rest of 2023. On the other hand, when there’s gridlock in Washington, it usually means that your hard-earned money is safe from wealth-destroying legislation.

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John Persinos is the editorial director of Investing Daily.

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