Is Inflation Truly Whipped?

Last week’s consumer price index report showing inflation — at least by some measures — had slowed in October to its lowest level since the beginning of the year set off a massive rally in stocks and bonds.

But is the market overreacting, and does the report necessarily imply that inflation has finally and truly peaked and that the Federal Reserve is just about done tightening? It may be a little too early to declare victory.

The report was at least encouraging, certainly, but whether we’re home free or not remains to be seen. The headline CPI rose 7.7% compared to a year earlier, down from September’s 8.2% pace and the smallest year-on-year increase since January.

The core index — which excludes food and energy prices — rose by 6.3%, down from the prior month’s 6.6% pace. But the monthly increase in headline inflation was 0.4%, unchanged from September.

Did all that justify a 5% jump in the NASDAQ last Thursday and the sharpest one-day drop in bond yields in more than 10 years, with the yield on the benchmark 10-year Treasury note falling to 3.83% from 4.15%? (The bond market was closed Friday for Veterans Day.)

If you believe Wharton professor Jeremy Siegel, who has been saying for months that the Fed is seriously overcounting inflation, then last Thursday’s massive rally was justified.

Not only did he tell CNBC that "inflation is basically over,” but that "we're in negative inflation mode if the Fed uses the right statistics, not the faulty statistics that they've been using."

Siegel specifically cited the cost of housing and rent, which he says are overinflated in the data the Fed uses to set interest rate policy. Once the Fed sees the light, he says, the markets are poised for a “good year-end rally," but if it doesn’t, we could be headed for a rate-driven recession.

There’s certainly reason to doubt the Fed’s competence to measure and assess home price inflation, which it has failed to accomplish the past several years and other times before that.

Despite blatant evidence that the housing market was overheating during and after the pandemic, the Fed continued to suppress interest rates, allowing home prices to skyrocket — and keep homeownership out of reach for more people.

Now that it’s put the brakes on monetary policy and mortgage rates have more than doubled since the beginning of the year, home sales and prices have come crashing down. Yet the inflation numbers don’t seem to adequately show that, Siegel says.

While it’s not clear that October’s CPI report sets the stage for a long-awaited and persistent slide in inflation, it probably should be enough for the Fed to at least lower its expected hike in its benchmark interest rate to no more than 50 basis points at its mid-December meeting, as opposed to the 75-bp increases it has imposed at its past four meetings.

No change seems too much of a reach, despite what Professor Siegel and the markets would want, but 50 bps seems the right way to end the year.

What happens after that, of course, is data dependent, although the quality of the data the Fed uses and how it chooses to interpret it is always questionable.

Another thing to consider is the results of the just-concluded midterm elections, which still have yet to be finalized but seem to indicate that the vaunted Red Wave failed to materialize, leaving either gridlock in Washington — which we’re told would be a good thing for inflation and the markets — or the Democrats retaining their slim, but extremely decisive, hold on power, which probably would not be.

Either way, the Fed is not likely to get help from the fiscal side in its fight against inflation.

As we saw in the short-lived tenure of Liz Truss as the prime minister of the U.K., a government promising tax cuts and heavy spending cannot peacefully coexist with a central bank determined to tighten monetary policy in order to rein in inflation. In London, the Bank of England prevailed and Truss was sent packing in record time.

In the U.S., should government fiscal spending continue to run amok — and there’s no reason to believe it won’t — the Fed will have to continue to swim against the inflationary current, meaning an easing in monetary policy is nowhere in sight, unless other factors start to wring inflation out of the system, such as an easing in supply chain bottlenecks, a quick end to the war in Ukraine, and a meaningful and fundamental drop in energy prices.

All of those things may actually happen. But it may be too early to pop the champagne corks.

George Yacik
INO.com Contributor

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.