‘Disinflationary wave is building’ even as investors anticipate aggressive Fed rate increase, says this economist

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According to a Capital Economics note, investors fear that Federal Reserve Chair Powell and his allies will continue to battle inflation through aggressive rate hikes, which have hurt both stocks and bonds.

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While it appears the Fed may announce Wednesday that it is raising its benchmark rate by three quarters of a percentage point for the third time in a row, Paul Ashworth, chief North America economist at Capital Economics, expects a less aggressive monetary policy soon. Policy stance may be followed.

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“If we are correct that inflation will return soon, officials will soon make a very small hike,” he said in a note on Tuesday. Referring to the consumer-price index, he said, “Continuous fall in gasoline prices and moderation in food inflation will impact the headline CPI in the next one or two months.” They also pointed to signs of deflation in the core CPI data, which exclude energy and food.

“Despite a more than expected 0.6 per cent increase in core prices in August, there are also growing signs of deflation,” he wrote. According to Ashworth, supply shortages have normalized, with indicators of the firm’s product shortages now suggesting that “inflation in core commodities could fall to 2% before the end of the year, up from 7% in August.” ”

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Capital Economics Note dated Sept. 20, 2022

The Federal Reserve is aiming to bring inflation down to its 2% target range through monetary tightening to crush stocks and bonds earlier this year.

US stock markets closed lower on Tuesday, as investors await clues on the Fed’s future rate hikes after the conclusion of its two-day policy meeting on Wednesday.

Dow Jones Industrial Average DJIA,
-1.01%
fell 1% on Tuesday, while the S&P 500 SPX,
-1.13%
fell 1.1% and the Nasdaq Composite comp,
-0.95%
According to FactSet data, around 1% slipped.

The fed-funds rate sits in a range of 2.25% to 2.5% ahead of the central bank’s anticipated rate hike on Wednesday. According to a Capital Economics note, fed funds futures suggest the rate could approach 4.5%.

“Those expectations are well above our own forecasts, primarily because we expect a further decline in inflation,” Ashworth said. Inflation in core services is rising sharply from rising fares, “but the latest measures by the private sector show that inflation for new leases is clearly slowing down,” he said.

In his view, “a wave of deflation is forming.”

“There are widespread signs of deflation in services, from a drop in airfares to hotel rates, while a fall in long-term inflation expectations has outweighed the risk of a price-wage spiral,” he said. “The result is that we expect to see clearer and more concrete signs of declining inflation in the CPI data soon.”

Meanwhile, higher real returns are weighing on stock prices and pushing corporate bonds higher, his note shows.

For example, the ICE BofA US High Yield Index option-adjusted spread index was up 4.88 percentage points on the comparable Treasury on Monday, up from 4.2 percentage points on Aug. 11. Federal Reserve Bank of St. Louis website,

Shares of iShares Boxx $ High Yield Corporate Bond ETF HYG,
-1.02%
FactSet data show, fell nearly 1% on Tuesday. The fund has posted a decline of 11.6 per cent this year on a total return basis till Monday.

Why are rising Treasury yields troubling the stock market ahead of the Fed’s next rate hike?

Credit: www.marketwatch.com /

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