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Is Fed Ready To Pivot As Inflation Slows?

By Shane NeagleStock MarketsAug 10, 2022 10:59AM ET
www.investing.com/analysis/is-fed-ready-to-pivot-as-inflation-slows-200628339
Is Fed Ready To Pivot As Inflation Slows?
By Shane Neagle   |  Aug 10, 2022 10:59AM ET
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The Consumer Price Index stood at 8.5% in July year-over-year, showing inflation rose at a slower-than-expected pace last month after the Fed’s two consecutive 75-basis-point rate hikes. The new print compares with the average economist estimate of 8.7%.

Month-on-month, prices remained relatively flat as energy and gas prices slumped by 4.6% and 7.7%, respectively. On the other hand, food and shelter costs rose 1.1% and 0.5%, respectively, in July. Core inflation, which excludes erratic food and energy costs, surged 5.9% year-over-year and 0.3% monthly, while analysts were expecting it to rise by 6.1% and 0.5%, respectively.

Falling energy prices and a tighter Fed stance are likely the main drivers of the deceleration to 8.5% last month. U.S. unemployment levels also dropped to 3.5%, a level not seen since before the pandemic kicked off.

How Are Markets Reaction To Weaker CPI?

The S&P 500 opened 1.7% higher, while the tech-focused NASDAQ 100 rose as much as 2.4% at the open on Wednesday after a weaker-than-expected July CPI print. On the other hand, the U.S. dollar fell sharply to trade above the $1.03 mark against its European counterpart, while the dollar index is trading at a one-month low.

Bitcoin is also trading higher – almost 4% – which is not surprising given its high correlation to high-risk, growth stocks.

As expected, U.S. bonds are rallying on the belief that the Fed may be preparing to make a pivot from its aggressive tightening of financial conditions. The benchmark 10-year yield is down 2%, to trade at 2.73%, which is a big drop given that it traded at almost 3.5% in mid-June.

The Bloomberg data shows that the swaps market is now pricing in a 50bps hike in September, which is helping stocks rally.

However, it is way too early to rule out a 75bps rate hike by the Fed as there’s a lot more data to come before the U.S. central bank meets in September. It is very likely that the market will be undecided on the size of the next move by the Fed as investors gauge economic data and comments from policy-makers.

Demand Destruction Or Simply Falling Energy Prices?

Raging inflation rates in recent months came as a result of strong economic growth in the U.S. as it recovered from the two devastating years of the coronavirus pandemic. The rebound was aggressively driven by the Federal Reserve’s low-interest rates and robust government stimulus.

But now the central bank faces a tough challenge involving aggressive interest rate hikes to address the hot labor market and restrain inflation, but without tipping the U.S. economy into a recession.

Following two 75 bps rate hikes in June and July, the Fed representatives are set to meet again next month to discuss its next move. Fed Chairman Jerome Powell said the central bank does not plan on slowing the pace of rate hikes before seeing clear evidence that red-hot inflation levels are cooling down.

“Even if headline inflation slows on account of weaker energy prices, but core inflation is stubbornly high, the Fed is likely to maintain its tightening bias as it will be concerned about high inflation being entrenched in consumer price expectations,” said Blerina Uruci, U.S. economist at T. Rowe Price.

Gas prices were on a decline since last month and have been falling for more than 50 days in the U.S., according to the energy data and analytics provider OPIS. The data from Florida showed that the average price of a gallon of regular gas in the state was $4.03 on Tuesday, nearly $1 cheaper than two months ago, although still higher on an annual basis. This price drop, as well as lower food and commodity costs, indicate that inflationary pressures have eased recently.

Even though the Fed tries to tackle overall inflation levels with its tight monetary policy, the central bank believes core prices represent a more reliable sign of future inflation. Law-makers and economists are particularly keen on monitoring core prices to see whether inflation is on its way to hitting the Fed’s 2% target in coming years.

The shift in consumers’ spending toward services has weighed on demand for goods, and this – as well as easing supply-chain constraints – has slowed down the pace of price increases of goods, which has been one of the key drivers of inflation.

Inflation Insights’ founder and president Omair Sharif said July has historically been an important month in terms of discounting, with price rises in plane tickets and hotels also easing as demand for summer travel eases.

“Demand has come off a lot in terms of bookings because people got the vacation they wanted and now they’re looking at their budgets,” said Sharif. However, major gains in a few individual prices may not make a significant difference, he added.

“Fed officials want to see sequential core inflation moderating,” he said. “But if it’s mostly coming from just a couple of areas, especially ones that may not prove persistent, then I’m not sure how much comfort that will provide.”

In addition to falling energy prices, economists also point toward the slowing economic growth The U.S. GDP data for June showed that the world’s largest economy shrank at an annual rate of 0.9% in the second quarter, marking the second straight quarterly decline and stoking fear among economists that a recession is imminent.

Summary

The U.S. consumer price growth was unchanged in July compared with June, signalling that inflation may have peaked in June. The weaker-than-expected CPI print was mostly driven by a sharp drop in energy prices. The stock market is rallying in response to better-than-feared July CPI data, which is a typical reaction in terms of the relationship between inflation and stocks. At the same time, yields and the dollar are heading in the opposite direction.

Investors will now shift their focus towards comments from the central bank officials as the market continues to bet on the size of the next rate hike by the Fed.

Is Fed Ready To Pivot As Inflation Slows?
 

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Is Fed Ready To Pivot As Inflation Slows?

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Comments (3)
David Beckham
David Beckham Aug 11, 2022 1:34AM ET
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All in short now
Seen see
ThurstonHowell Aug 10, 2022 1:55PM ET
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8.5%. LOL PIVOT
Mike Caldera
Mike Caldera Aug 10, 2022 11:41AM ET
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Over 129 million barrels of oil have been released from the SPR over the past 12 months. Oil will go back up. Be Prepared
 
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