Friday's Market Minute: Disinflation Tailwinds Are Fading

It’s been a volatile trading week despite an inflation report for both core and headline inflation that came in roughly in line. Investors remain optimistic that the Fed won’t need to raise rates in September even as July CPI rose less than estimates at 3.2% year-over-year due to base effect comparisons versus June coming in at 3.0%.

The implications of economy wide disinflation for equity markets have been bullish year-to-date, and another hike in September could alarm investors. The data are supportive of another "pause" by the Fed in interest rate hikes. However, there’s still a long way to go with regards to inflation even though significant progress has been made. Core inflation has been sticky due to shelter costs, but more improvement to the downside for households is expected for the remainder of the year. 

From a top-down perspective, there are still concerns that equity investors must remain aware of as we pace towards the end of the year. Inflation is still a threat, broad equity valuations are not cheap when compared to historical averages, and recession risk remains elevated even though it has diminished. Equities also face real competition from fixed-income and investors seeking more tolerable risk-adjusted returns in bonds.

Taking into consideration recent equity market performance since the third week of July, and yesterday’s post inflation report sell off throughout the day, one could come to the conclusion that CPI data may no longer act as a so-called tailwind for financial markets in the next few months.

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