This week saw the perfect response from the markets when an uncertainty such as inflation, is resolved. Although the broad indexes are clearly overbought, right now my only concern is the uncertainty isn’t so much resolved than merely being a little diluted. It’s a first step, and a great one, but it may be too early to say inflation has peaked. When CPI declines from 9.1% and PPI declines from 11.3% to 8.5% and 9.8% respectively it’s worth exploring the reasons and not ignoring that the numbers are still historically high. Let’s dig a little deeper into our favorite trio.
In my opinion, the Fed is unlikely to divert from its aggressive goal to bring inflation down. That’s because the economy is doing exactly what feeds that goal by moderating. For example, there is a data set called the Leading Economic Indicator (LEI), which tracks business, markets and the economy from different sectors and is historically focused on by economists as a measure of broad economic stability. It is released monthly and when three month over month changes show a decline that is considered a strong sign of moderation in the broad economy. The inversion of the yield curve, customarily predictive, although on a wide timeline, of a recession, has inverted multiple times since the end of last year. Which brings us to inflation, where even this week’s modest declines are consistent with a moderating economy as well. The data is still choppy, so it still pays to be patient.
I’ve previously viewed the war in Ukraine and the economic challenges of China as mutually exclusive. Although the war in Ukraine has recently been joined by the tenuous military exercises near Taiwan that China has used to change its narrative. One narrative is the fragile condition of the Chinese economy, and another is the 13th National People's Congress of the People's Republic of China elections in 2023. Any material changes in the outcome are harder to predict than Russia’s Putin, who isn’t likely going anywhere, but the threat of military actions based on perceived sovereign rights has as much chance of escalating than deescalating. On a constructive note, McDonald’s announced the company would be reopening restaurants Ukraine. Could this be a source of uncertainty dilution in the future?
Most comments regarding the recent introduction of the Inflation Reduction legislation suggests that the impact of the 15% minimum corporate tax will be centered on a number of large tech companies, who’ve historically had access to favorable taxable conditions. The 1% tax meant to discourage stock buybacks, might have a constructive impact on dividend growth. And spending on other familiar projects is, well, just spending. In my opinion it will have little overall impact on the broad markets, but it also won’t likely reduce inflation. The last point worth noting is the recent sharp declines in energy prices, which were the primary catalysts for the recent declines in inflation. This week’s data was met with new increases that at this time shows WTI Oil (domestic) approaching $95. Should oil touch or exceed $100 that would have direct impact on inflation data. Likewise, Natural Gas, currently at $8.80 is high and could move higher as the summer season moves into fall. All of these observations suggest the inflation uncertainty is currently a little diluted, but it’s too early to predict neither how aggressive the Fed will be next month, nor if the Fed will ease rates in 2023. There is historic precedent for such quick Fed turnarounds, but that just defines the narrative, it doesn’t confirm it.