Good News For Markets As Fed’s Preferred Inflation Metric May Have Peaked

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Today’s PCE inflation numbers were relatively good news for the markets, suggesting that inflation could ease into the summer. The annual price change for April 2022 was 6.3%. That’s down from 6.6% in March, as goods prices rose at a slower pace than before and prices for services grew at a broadly similar rate in recent months.

Excluding food and energy, annual inflation fell back to 4.9%, the rate of growth we last saw in December 2021. It is too early to be sure, but inflation may subside. Of course, inflation is still well above the Federal Reserve’s 2% target, but the direction is potentially positive.

Metric the Fed Watches

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This matters because PCE inflation is a metric that the Fed clearly watches, and was mentioned seven times in the minutes from the May 2022 Fed meeting minutes. Those minutes also made it clear how concerned the Fed was about inflation. Recent inflation data could enable a somewhat calmer situation at the Fed’s next meeting and perhaps an equally less hawkish currency on rates.

Is inflation at its peak?

Inflation is a relatively noisy range from month to month and inflation remains very high by historical standards. However, today’s report indicates that inflation may be peaking, assuming there have been no further major events such as disruptions in energy markets or the widespread Chinese COVID lockdown.

Being past peak inflation is not something the Fed was comfortable saying at its May meeting earlier this month, so if it does happen it could eventually signal a change in their thinking. It will also take a few more months of data to confirm the trend, but the associated inflation could rise higher from here, at least taking some comfort from the recent data.

cpi data

Furthermore, separate CPI data for April 2022 told a similar story with a sudden increase in prices month-on-month, used cars and clothing actually declined month-on-month and the energy chain, Remaining highs but softer than extremes of March’s high.

If inflation continues to ease, the Fed may have an opportunity to dial back some of the more aggressive rate hikes planned for 2022. This will be positive for both the stock and bond markets.

According to futures markets, the fed funds rate is expected to drop from less than 1% today to close to 3% by December 2022. However, with the recent inflation news, markets now view more extreme rate hike scenarios as slightly less likely.

Rates are still expected to rise, but perhaps not as high and not as rapidly. A ‘double’ 50 bps hike next month remains on the cards for most Fed watchers, but expectations of how fast rates will rise thereafter are starting to soften.

good news for the markets

Overall, this is good news for the markets. Inflation concerns, and the likely reaction of the Fed, have been a major driver of bear markets for many stock indices in recent months.

Of course, there is no sea change, we are still in a rising rate environment for 2022, but perhaps a somewhat more extreme interest rate scenario becomes less likely if inflation is indeed peaking. Of course, we’ll know more once the May CPI data is released on June 10. The Fed will look at it ahead of the June 14-15 meeting scheduled to set rates.

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