Today’s PCE inflation number was relatively good news for markets suggesting inflation could trend lower over the summer. The annual price change for April 2022 was 6.3%. That’s down from 6.6% in March, as prices for goods rose at a slower pace than previously and price increases for services rose at a broadly similar rate to recent months.
Stripping out food and energy, annual inflation fell back to 4.9%, a rate of growth we last saw in December 2021. It’s too early to be sure, but inflation may be trending lower. Of course, inflation is still well above the Federal Reserve’s 2% target, but the direction is potentially a positive.
The Metric The Fed Watches
This matters because PCE inflation is a metric that the Fed clearly watch, and was mentioned seven times in the minutes from the May 2022 Fed meeting minutes. Those minutes also made very clear just how concerned the Fed was about inflation. Recent inflation data may enable a somewhat calmer position at the Fed’s next meeting and perhaps a correspondingly less hawkish posture on rates.
Has Inflation Peaked?
Inflation is a relatively noisy series month-to-month and inflation remains stubbornly high by historical standards. However, there are signs in today’s report that inflation may have peaked, assuming no further major events such as disruption in energy markets or widescale Chinese covid lockdowns.
Being past peak inflation is not something the Fed was comfortable saying at their May meeting earlier this month, so if this holds it may ultimately prompt a change in their thinking. It will also take a few more months of data to confirm the trend, but those concerned inflation may spike higher from here can at least take some comfort in the most recent numbers.
Also, separate CPI data for April 2022 told a similar story with an abrupt month-on-month slowing of price increases, with used cars and clothing actually falling in price month-on-month and energy series, remaining elevated but softening from the extreme highs of March.
If inflation is coming down, then the Fed may have the opportunity to dial back some of the more aggressive rate increases planned for 2022. That would likely be a positive for both the stock and bond markets.
Currently the Fed Funds rate is expected to shift from just under 1% today to closer to 3% by December 2022 according to futures markets. However, with recent inflation news, the markets now view the more extreme rate hike scenarios as a little less likely.
Rates are still expected to go up, but perhaps not quite so much and quite so fast. A ‘double’ 50bps hike next month remains on the cards in the view of most Fed watchers, but after that expectations for how fast rates rise are beginning to soften.
Good News For Markets
Overall this is good news for markets. Inflation concerns, and the Fed’s likely reaction to it have been a key driver of the bear market for many stock indices in recent months.
Of course, there is no sea change, we are likely still in a rising rate environment for 2022, but perhaps some of the more extreme interest rate scenarios become less likely if inflation has indeed peaked. Of course, we’ll learn more once the May CPI data is released on June 10. The Fed will see that before their scheduled June 14-15 meeting to set rates.
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