Inflation has been the hot button issue in markets for over a year now, and it has rightly become the focus not only of Central Bankers and investors, but of politicians and everyday consumers. A rise in prices and the source of that rise is a hotly debated issue—but the debate is beginning to change.
Signs of that change are in this very good article from the Wall Street Journal, which brings up an important layer of complexity in economic and financial analysis that is often overlooked: the vector.
Before we get into that, let’s talk about what we’ve been seeing. Overall, the CPI (as well as the PCE, but we’ll stick with CPI for now), has been on a rocket ship upwards—but the 9.1% print we saw in June for overall CPI wasn’t as important as the 5.9% core CPI print.
This is important, because the headline inflation number includes food and energy, and higher oil prices have been the primary driver of inflation there. But we’ve seen oil prices fall since they peaked in early June, and while they haven’t hit pre-bull market levels, there is an indication that the peak in oil prices is already behind us for this cycle.
That should suggest a convergence of core and headline CPI with the latter falling to the former’s level, which in turn will result in lower price levels more broadly. That would be good for the consumer and the economy, and it could also drive the Federal Reserve to slow down their own pace of interest rate hikes that has been a big (if not the primary) factor in the recent market selloff.
The question to ponder now, however, is to what extent price growth will slow and when this will happen. Going from, say, 9.1% in June to 5% in July would be a massive rally moment; going from 9.1% to 9% would be a disappointment.
What analysts need to do now is collect as much data as they can and try to pinpoint not just how much inflation there will be, but the slope of the change. Will inflation slip significantly to a lower level? Will it slide more gradually over several months? Or will it go up and down in a volatile and confusing pattern of seeming randomness? The market will have very different responses to these scenarios, so analysts will need to know which one to expect when they try to size up how the market will respond—and what investment strategies are most appropriate.