Markets React: August Inflation Reading Higher than Expected

The Consumer Price Index (CPI) report for August 2022 suggests inflation is moderating, but not as fast as investors had hoped. On a year-over-year basis headline CPI increased 8.3% versus an 8.1% expectation, while ‘core’ CPI (excluding food and energy prices) increased 6.3% versus a 6.1% expectation^[1].

The August CPI ‘miss’ resulted in a sharp sell-off in both the stock and bond markets as prospects increase for sharply higher interest rates throughout our economy and a more protracted economic slowdown. The S&P 500 fell 4.3% on Tuesday, the largest one-day decline in over two years, while two and ten-year Treasury yields increased 20bp and 9bp, respectively^[2].

To be sure, the year-over-over year increases for both headline and core inflation have fallen from earlier in the year, but the improvements are likely too modest to deter the U.S. Fed from continuing on its aggressive quantitative tightening path. The Fed funds futures market now suggests a 75bp-100bp increase in the Fed funds rate at the upcoming September meeting (up from a 50bp-75bp increase one week ago) and the potential for continued increases through mid-2023^[3]. Prior to the August inflation data, the Fed funds futures market suggested the Fed would be done with rate increases by the end of 2022.

On a positive note, energy prices are falling with WTI crude oil prices and regular unleaded gasoline prices down approximately 30%^[4] and 25%^[5], respectively, from their highs earlier in the year. Food, housing, and utility prices are still on the rise, but we are hopeful for some moderation in the upcoming months.

As we have written previously, we expect volatility in the financial markets to stay elevated in the near term. The Fed still has a way to go on its quantitative tightening path, and we expect economic and corporate earnings releases in the coming months to contain a mixture of positive and negative results providing fodder for both bull and bear viewpoints and market volatility.

We also expect corporate earnings estimates to fall reflecting the anticipated slowdown in economic growth, which along with still high inflation and increasing interest rates may negatively impact stock valuations and prices. As such, we continue to have a cautious view on the economy and financial markets. Evidence of a marked deceleration in inflation would provide a basis for a more constructive viewpoint.

In the meantime, we advise clients to assess and plan for near-term liquidity needs but remain focused on long-term investment goals and objectives. When and where appropriate, we view periods of market weakness as an opportunity to buy good companies at lower prices and to improve a portfolio’s overall credit/risk posture.

Please reach out to your investment team should you have any concerns regarding the financial markets, economy, or your portfolio. An assessment of your portfolio’s asset allocation in relation to your investment objectives and planning for near-term liquidity needs are always a beneficial exercise.