Rob Clarry, Investment Strategist at Evelyn Partners, comments on the latest US CPI inflation data:
US headline CPI inflation rose 7.7% year-on-year in October (consensus: 7.9%), compared to 8.2% in September. On a monthly basis CPI rose 0.4% (consensus: 0.6%) compared to a 0.4% rise last month. This headline reading was driven by increases in shelter, gasoline, and food.
Core CPI inflation, which excludes food and energy, came in at 6.3% (consensus: 6.5%) year-on-year, which compares to a 6.6% rise in September. On a monthly basis, core CPI rose 0.3% (consensus: 0.5%), versus 0.6% rise in September.
After a year in which inflation has consistently surprised to the upside, today’s CPI report finally brought some good news. October’s inflation print surprised to the downside, with both the annual and monthly figures weaker than expected. The 0.3% increase in core inflation was the softest reading since September 2021.
Despite headline inflation remaining some way above the 2% target, we remain optimistic that inflation will ease from here and into next year. There are several forward-looking indicators that point to lower inflation in 2023. For example, several housing indicators point to a fall in shelter cost inflation and goods inflation should continue to fall. We expect labour market tightness to ease as the full effect of this year’s interest rate hikes feed through into the real economy. Indeed, the consensus expectation amongst economists is that CPI should fall to around 3% by the end of 2023.
The immediate market reaction to today’s CPI print was positive. S&P500 futures spiked +2.5% as investors hope that this will be the start of a continued deceleration in headline inflation.
Looking to 2023, the key question is: will Jerome Powell follow through on his intention to keep Fed policy tight? So far, he has been talking tough on inflation. But assuming it peaks early next year, the temptation will be to start easing policy. While this would be welcomed by equity investors, we are concerned that this could lead to further inflationary spikes in the second half of 2023. Given high levels of uncertainty around the direction for future policy, we favour portfolio diversification over high conviction bets.
Whether or not the US midterm election results will impact the Fed’s calculus remains to be seen. The Fed is supposedly independent, but in recent months it has come under significant political pressure as the Democrats hoped for lower inflation ahead of the midterms. Maxine Waters, the Chairwoman of the House Financial Services Committee, wrote to Jerome Powell urging him to pause the hiking cycle. But will the Democrats now be hoping for a slowdown in 2023 to give the economy time to recover ahead of the 2024 Presidential Election? While these factors are likely to weigh on Fed decision making, their primary focus will remain on the economy. With the labour market continuing to look tight and inflation remaining some way above target, we expect policy to remain restrictive into the first quarter of next year.
In summary, this does not change our view that the Fed will continue to stay the course with its plans for tighter monetary policy in the coming months. However, we do expect smaller rate hikes following four consecutive 75 bps hikes.
With the Fed nearing the peak of its tightening cycle, we are looking to gradually add duration risk to our fixed income portfolios. From an equity perspective, we continue to favour names in defensive sectors like healthcare, utilities, and consumer staples.