Inflation Not Yet Rolling Over
We have often commented in our Riggs’ Reports and investment market updates that the markets do not like surprises. Yesterday, the markets expected the Consumer Price Index report to show a decrease in prices, indicating inflation was peaking. This would give the Federal Reserve some latitude to slow its hiking of interest rates. The market was wrong, resulting in a strong sell-off in equities, bonds, and cryptocurrencies. The strong days leading up to the Consumer Price Index report were erased in one session.
The Consumer Price Index (CPI) ticked up 0.1% in August, contrary to the consensus expectations of
-0.1%. While energy prices declined 5.0%, down for the second consecutive month, that was insufficient to offset the increases in most other categories. Even in energy, the decline was only in gasoline prices, while electricity and natural gas prices rose. Food prices advanced 0.8%, the least this year, but nearly four times the average monthly gain since 1990.
The biggest driver of the monthly change in the core CPI was shelter, which has a weight of over 40% in that index. The rise in shelter costs was the biggest gain since June 1990. Despite the decline in housing market activity this year, the softer home prices will not be reflected in the CPI for some time.
On a year-over-year basis, the CPI eased only slightly to 8.3% from 8.5% in the month before, missing the consensus of 8.0%. Notably, food prices surged 11.4% from a year ago, the steepest rise since May 1979. Food at home prices jumped an even bigger 13.5% year over year, also the most since 1979. Core CPI climbed 6.3% year over year, above the consensus of 6.0%.
Such broad-based inflation pressures reflect continued demand/supply imbalances. Consumer demand remains strong, supported by low unemployment, excess savings accumulated during the pandemic, and the ongoing post-pandemic shift back toward more services consumption versus goods. At the same time, while some supply chain problems have eased, others, such as labor shortages, have persisted. This underscores the difficult task for the Federal Reserve to bring inflation down without causing a recession. We expect inflation to moderate in the final few months of this year but to finish 2022 well above the Federal Reserve’s average inflation target of 2.0%.
So, what does this mean for investors? Next week the Federal Reserve will meet and likely raise short-term interest rates by 0.75% or even as much as 1%. If inflation does not begin to show signs of rolling over, it will strengthen the case for continued aggressive tightening by the Federal Reserve. We expect investment markets to grind lower over the next couple of weeks. Investment markets will face some pressure in the coming days and weeks.
While tactically, we must be sensitive to near-term market expectations, it is essential to remember that as investors, we must look ahead to identify the investment market opportunities. The investment team has used this period to identify companies likely to be the next market leaders. Companies that can grow revenue strongly during this challenging period and show effective management and leadership will likely be rewarded with outsized returns when the market volatility subsides. We have been incrementally adding positions to those companies that are showing strength in a challenging environment.
We expect that there are still some tough days ahead of us in the near term but that this volatility is providing opportunities to purchase companies with solid fundamentals and growth prospects at a discount. We are working hard to position portfolios to weather Fed Action and take advantage of the market when uncertainty has lifted.