Opinion by Clifford Bennett, Chief Economist at ACY Securities
We were aware that gas browser prices had dropped back significantly, which opened the door for the pullback in consumer inflation expectations that we saw a few days earlier.
Then, there are the slightly reassuring attempts to re-establish food exports from Ukraine and Russia. This has seen some moderation in food prices too.
The problem is that even a retreat to around 5%, inflation is highly problematic in an already slowing economy.
The silver lining would appear to be the prospect of a resultant slowing in the US Federal Reserve rate hikes. Certainly, they will be pleased with this latest data.
However, it is only one month, and, likely, they will again raise rates at the next FOMC by 75 points. At least the risk of a 100-point hike is off the table now. Should this reversal in inflation be sustained with the next month’s data, then the Fed could go on full pause to wait, watch and see from there.
Markets reacted with a leap higher in the first five minutes post the release but failed to continue significantly higher from there. The Nasdaq did not even make a new high. The US500 only managed around 8 points more.
What this shows us is that there was a relative balance of buyers and sellers after the release of this data. This could prove telling. Certainly, the strong daily closes will encourage the price action analysts of a significant resumption of upward momentum.
Though when we consider the gains on the day were just immediate pricing higher and not based on an imbalance of interest either way, there is cause for slight suspicion.
Could it be that both inflation and the equity market are peaking at about the same time?
Not a common suggestion on the day, but then, the uncommon has become the mainstay of market behaviour over the past two years.
The expectation of a peak in inflation around current levels, above 9%, not unrealistic, may have already been priced in by the very impressive stock rally over the previous month. There may simply be too many people waiting to take profit on long positions upon an inflation reversal.
It is the case that most of the funds management industry is already long, on the belief that recession will lead to lower bond yields as inflation drops away.
Hence, the potential for market long positioning has now gotten ahead of itself.
Why was the market unable to kick on after the first re-pricing high? Which was within just a few minutes of the data release?
My central theme remains that the US economy is in much more trouble than just a momentary technical recession. That there are real forces of decay at work.
Profit margins were fattened momentarily, hence strong earnings, but these margins are again being eaten away by higher labour costs, declining productivity, and simultaneously higher borrowing costs.
In these circumstances, it is possible that equity markets will again need to price in a significantly weaker economic outlook than they were expecting. Much as occurred across the first half of the year. This would point to the risk, as I have highlighted recently, of another 20% decline from existing levels.
What would surprise the market the most at this point? A simultaneous peak in both inflation and equity market pricing.