Markets are waking up to the notion that inflation has not peaked.

It only took a 0.1% rise in consumer-price inflation last month to send markets to their worst tail end in two years.

But what may seem relatively high – coupled with the fact that the number of headlines is declining every year – indicates a more significant shift in markets.

Nomura’s Charlie McElligott said in a note published Wednesday morning that markets are now bracing for a “hard landing” for the U.S. economy as investors realize inflation will be more stubborn than they expected.

Other investors have pointed out that their belief in “hyperinflation” – the notion that inflation has already fallen from energy prices seen earlier this year – and are now being forced to face reality. Factors such as rising rents will become more rigid, meaning the Fed will have to keep interest rates on hold for longer.

“I think some investors are confused by the sense that inflation may come down too quickly,” said Mohannad Amma, portfolio manager at Bim Capital.

“The Fed has unemployment and the CPI shelter unit in their hair,” he said.

watch outDespite lower gas prices, US inflation rose in August, CPI shows

Ahead of Tuesday’s consumer-price index report, economists had expected falling energy prices to keep inflation essentially steady.

Instead, a surprisingly sharp rise in rents and owner-occupier-equivalent “core” inflation — inflation that strips out volatile food and energy prices — rose 0.6 percent in August, more than double the previous month’s increase. That’s about double the 0.3 percent expected in a survey of economists published by the Wall Street Journal.

watch outAmerica gained 315,000 jobs in August. The labor market is still strong but shows signs of slowing down

Traders are raising prices on the grounds that it will be difficult to fight inflation. According to CME’s FedWatch tool, they now see about a 30% chance that the Fed will raise interest rates as high as 4.5% in July and a 15% chance that it will rise as high as 4.75%.

Moreover, traders are pricing in near 30% odds that the Fed will raise a full percentage point when they meet next week, which investment bank Nomura, McElligott’s employer, is already expecting.

See: Biggest Fed Rate Hike in 40 Years? It can come next week

As McElligott explains, high interest rates are bad news for stocks because they can hurt consumption and capital spending by companies, ultimately resulting in lower economic growth and lower corporate earnings.

CPI data released Tuesday showed that both rent and owner-equivalent rent prices — which the Fed uses to represent the costs associated with home ownership — rose 0.7 percent in August.

Fed Chairman Jerome Powell has made it clear that the Fed wants to slow rising housing prices before returning to easy monetary policy.

To be sure, others worry that the Fed risks becoming too aggressive.

Christina Hooper, Invesco’s chief global strategist, said in an email that “75 is the new 25” — meaning the Fed could do unnecessary economic damage by continuing to make jumbo rate hikes.

“The impact of rate hikes takes time to show in economic data, and so any central bank with a 75 basis point hike is turning monetary policy into a more opaque instrument and risks overdoing it,” Hooper said in emailed comments.

Ama agreed that the economy could see an even worse downturn before the full impact of the Fed’s rate hike is felt. But this does not mean that the central bank should back down, he said.

“Just as the Fed delayed hiking and let inflation out of the bag, more aggressive hikes could do much more damage before the full impact of previous hikes is felt,” he said.

The sad fact is that “high inflation” is one of those things that can only be confirmed in hindsight, Aama said.

So far, US stocks have struggled to shake off the effects of Tuesday’s carnage. S&P 500 SPX,
+ 0.34%
Slightly lower in afternoon trading, the Nasdaq Composite COMP;
+ 0.74%
and the Dow Jones Industrial Average DJIA,
It rose 0.2%.

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