Inflation Report Provides a Welcome Relief

Yesterday’s inflation report was a welcome sign for equity and bond bulls alike. The headline reading dropped more than expected to 7.7% from a year ago, which is noticeably better than the peak reading from June of 9.1%. Core inflation was up 6.3% for October, pulling back from the previous month’s four-decade high of 6.6%.

Lower-than-expected CPI data eases pressure on the Fed to maintain its policy of aggressive interest rate raises to combat price pressures. Inflation has been slow to come down, and the latest optimistic report gives investors hope that this deceleration might bring back the narrative of a soft economic landing. 

However, the implications of the recent CPI report are not universally positive for the economic outlook. Indeed, a surprisingly weak inflation reading likely reflects softer consumer spending, and increased margin pressures for the corporate sector cutting into profits. The longer rates stay at a level that is constraining economic activity, the greater the odds of the economy tipping into a recession.

Despite yesterday’s rally, we must not forget the Fed maintains a hawkish policy stance of demand destruction via higher interest rates and reduced financial liquidity to dampen inflation with higher unemployment and slower economic activity. If this downward trajectory for inflation continues into next month and the pace of rates hikes moderates, then a cautious case can be made that U.S. equities may end the year on a strong note. 

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