Fed Making Progress on Bringing Down Inflation

Financial markets spent most of this week digesting the gains that followed the release of the October CPI report. The Consumer Price Index, which measures inflation, rose 7.7% vs expectations of 8.1%. Almost every CPI report this year had come in hotter than expected, so both stocks and bonds surged higher on the better-than-expected report.

While inflation is still high there is good news when you take a look at prices for many of the items that were early indicators that inflation was going to soar.

Let’s start with housing. The Covid pandemic led to an increase in demand for houses. When the Federal Reserve cut the Fed Funds rate to near 0% in March 2020, mortgage rates fell to under 3%. Throw in trillions of dollars in stimulus from the government and the Fed and home prices surged.

This surge came to a halt this summer as the Fed’s aggressive rate-hike campaign led to higher mortgage rates. Home prices declined in July & August, the first monthly decline in over 10 years. We fully expect that once data is released for September and October it will show price declines have continued.

For more of a real-time view of housing we can take a look at the National Association of Home Builders survey which asks the home builders to rate current conditions. This fall the index has had one of the largest declines in conditions in over 30 years. Cancellation rates are as high as 35% for some of the builders.

Wells Fargo, who is one of the largest mortgage providers in the country, saw mortgage applications fall 90% from a year earlier according to CNBC.

The second half of 2021 was not an ideal time to be in the market for a used car. Due to supply-chain disruptions, there was a major shortage of new car inventory, which led to a major increase in demand for used cars. The good news is that in the last nine months new car inventory has slowly improved and that, along with higher auto loan rates, has led to a 15% decline in used car prices since January.

Last year freight costs skyrocketed and one measure of that was the tripling of the price to ship a container from Shanghai to Los Angeles. That is no longer the case as the price has fallen from a high of over $12,000 to $2,400. Many trucking companies have said that freight costs have declined double-digits compared to 2021.

In 2021 the rise in the ISM Manufacturing Prices Paid Index was once of the first signs of higher inflation. Over the last six months this index has come down significantly, which will translate into lower cost pressure for businesses.

On the commodity side, oil prices have fallen from $125/b in June to $79/b today. Lumber has declined 70% since March and wheat has declined 35% over the last six months.

It is clear to us that inflation has peaked and is heading lower. Now that does not mean the Fed’s job is done. Inflation is still too high. But it does mean that the aggressive rate hikes and quantitative tightening that the Fed has used this year are working.

One more thing, please take a look at the chart below. We have entered the best six months of the four-year presidential cycle. Going back to 1950 the S&P 500 has been higher six months after the midterm election all 18 times. Not a single time has the S&P been lower. In addition, the average gain in that six-month period was 15.2%. Of course, it is foolish to invest based on just one data point, but seasonality is important to take into consideration.

So, it is good news that the Fed is having success bringing down inflation, right? Well yes, but the Fed needs to be careful here not to raise rates too far, too fast. This has been a mistake they have made often in the past. Our next post will examine what the Fed has done to this point, what is on the horizon and what the implications are for your portfolio. Have a great weekend.