Finally! After months of aggressive interest rate increases, the Fed might be making some headway to lower inflation. Last week’s Consumer Price Index (CPI) report for October finally showed that inflation is starting to cool substantially. Truth be told, inflation has been coming down all summer now, but it just wasn’t coming down fast enough. Last month’s CPI report showed that while inflation grew by 7.7%, it was well off its peak of 9% in June and below many estimates (see the white line below).  The cooler-than-expected inflation sent stock and bond markets higher.

So, what exactly is going on with inflation? Set aside the debate about health insurance costs, prices for many things have begun to moderate. Costs for goods like clothing, home furnishings, and used cars have been declining for months as many retailers are overstocked with inventory. It’s not just goods anymore. Now prices for services like airfare and medical services are starting to moderate as well. On top of that, there are expectations for housing and rents (the largest component of CPI) to start coming down too over the next few months.

The cooler inflation data was a welcome sign after a rough year for bonds; they have taken the brunt of the pain of rising interest rates. Inflation numbers remain too high for the Fed so there is still more work to be done. It is too soon to expect them to stop raising rates. I expect that inflation won’t be coming straight down like it did during the Great Financial Crisis. The path of inflation could be more jagged like it was during the 70s rising and declining throughout the decade. We will likely run into a few months ahead where inflation might even accelerate again which could cause the Fed to be more hawkish. There are still many risks ahead. Like we’ve been saying all year, don’t wait for the “all clear” sign. Once data like inflation, unemployment, and GDP shows that things are all clear, the markets probably have rallied ahead of that.

Benjamin Lau, CFA
Chief Investment Officer & Principal

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