Turning the corner on the inflation crisis

Note: A version of this article was originally published on TKer.co.

Stocks rallied last week, with the S&P 500 climbing 2.2% to close at 4,514.02. The index is now up 17.6% year to date, up 26.2% from its October 12, 2022 closing low of 3,577.03, and down 5.9% from its January 3, 2022 record closing high of 4,796.56.

Here’s some good news: Thanksgiving dinner has become less pricey.

According to the American Farm Bureau, the average cost of a Thanksgiving dinner for 10 costs $61.17 this year, down 4.5% from last year.

“The centerpiece on most Thanksgiving tables — the turkey — helped bring down the overall cost of dinner,” the Farm Bureau observed. “The average price for a 16-pound turkey is $27.35. That is $1.71 per pound, down 5.6% from last year.”

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It’s the latest encouraging development in the Federal Reserve’s long fight to bring inflation down.

While prices for most goods and services aren’t deflating as they are for turkeys, the inflation rates have certainly eased. And, importantly, concerns about prices are receding.

Signs the inflation crisis is over

According to BLS data released Tuesday, the Consumer Price Index (CPI) in October was up 3.2% from a year ago. Adjusted for food and energy prices, core CPI was up 4.0%, the lowest since September 2021.

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On a month-over-month basis, CPI was unchanged as energy prices fell 2.5%. Core CPI was up a modest 0.2%. If you annualize the three-month trend in the monthly figures, CPI was rising at a 4.4% rate and core CPI was climbing at a 3.4% rate.

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While many broad measures of inflation continue to hover above the Fed’s target rate of 2%, they are way down from peak levels in the summer of 2022. And the trend suggests they could continue to move lower.

Among the most visible price categories is gasoline, which many consumers confront regularly. And it’s been cooling.

“With Thanksgiving fast approaching (and maybe the in-laws), the national average for a gallon of gas is steadily declining,” AAA observed on Thursday. “Since last week, pump prices have fallen six cents to $3.34. Since the price peak for 2023, the national average has either fallen or remained flat for 60 straight days.”

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This comes as oil prices tumbled by more than 20% from their recent highs.

Indeed, consumers confirm they have taken notice of recent price trends.

From the New York Fed’s October Survey of Consumer Expectations: “Median inflation expectations declined at the one-year and five-year ahead horizons in October, falling to 3.6% from 3.7% and to 2.7% from 2.8%, respectively. Median inflation expectations at the three-year ahead horizon remained unchanged at 3.0%.”

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This is a marked improvement from June 2022, when consumers were looking for 6.8% inflation in the year ahead.

Corporate executives have also taken notice.

According to Bloomberg’s Michael McDonough, the number of discussions on inflation in S&P 500 earnings calls has been trending lower for more than a year.

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Financial market professionals are also a little less worried about inflation.

According to Bank of America’s Global Fund Manager Survey, inflation had been identified as the “biggest tail risk” almost every month since March 2021. But according to the October survey released on Tuesday, it was replaced by geopolitics.

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Another indicator: Wholesale prices actually contracted in October, with the Producer Price Index falling 0.5% month over month in October.

‘The hard part is over’

In a research note laying out their 2024 outlook for the U.S. economy, Goldman Sachs economists declared: “The hard part is over.”

“More disinflation is in store over the next year,” the economists wrote. “Although the normalization in product and labor markets is now well advanced, its full disinflationary effect is still playing out, and core inflation should fall back to 2-2½% by end-2024.”

While discussing Walmart’s financial results, Walmart’s CEO Doug McMillion even said: “In the U.S., we may be managing through a period of deflation in the months to come. And while that would put more unit pressure on us, we welcome it because it’s better for our customers.”

Sure, policymakers and most other folks still want overall inflation rates to come down a bit more. And in this process — and after this process — inflation will continue to represent a source of risk and uncertainty.

But I think we can probably say the crisis is over.

The ‘Goldilocks’ soft landing

I have no doubt that people will continue to complain about prices levels. After all, low inflation just means prices will rise from current levels but just at a moderate rate. (If you want prices to outright fall, you’re talking about deflation, which is a whole other scary beast.)

And just as in boom times and in busts, there will continue to be people struggling with costs.

But at the macroeconomic level, the confluence of price data seems to increasingly support the idea that we are experiencing a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.

This narrative — which TKer has been advancing weekly since the beginning of the year — has even taken on renewed interest in the big business news outlets. Some headlines via CNBC’s Carl Quintanilla:

This is not to say the economy has a totally clear path ahead of it. Indeed, there are some warning signs emerging suggesting there could be more slowing ahead.

But for now, I think we can close the book on the inflation crisis we’ve been talking about for the last two years.

Reviewing the macro crosscurrents

There were a few notable data points and macroeconomic developments from last week to consider:

Inflation cools. We got a lot of data on inflation in the past week. You can see it all above.

Spending cools from record levels. Retail sales ticked lower from record levels, declining 0.1% in October to $705.0 billion. It’s worth noting that September’s initial print of $697.6 billion was revised up to $705.7 billion.

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From Wells Fargo: “Consumer spending may be losing a bit of momentum, but not as much as had been widely expected given the recent deterioration in various measures of consumer sentiment.”

Mixed signals from the major retailers. Big box retailers Walmart and Target announced their quarterly results.

Here’s Bloomberg on Walmart: “Walmart Inc. modestly raised its annual profit forecast but struck a cautious tone about the outlook for US shoppers after signs of weakness at the end of October. There was a ‘sharper falloff’ in sales during the last two weeks of October, Chief Financial Officer John David Rainey said in an interview Thursday as Walmart reported financial results. Demand picked up in November, spurred in part by seasonal offerings.”

Here’s CNBC on Target: “Target on Wednesday topped Wall Street’s quarterly sales expectations and blew past earnings estimates, as purchases in high-frequency categories like food and beauty helped prop up weaker customer spending… Yet the big-box retailer stared down the same challenges that it has faced over the past year. Shoppers aren’t buying much more than the necessities. They’re hungry for lower prices. And when they do make purchases, they’re postponing them – such as waiting until the temperature drops to buy a pair of jeans or a sweatshirt, CEO Brian Cornell said on a call with reporters.”

Spending is holding up, according to credit card data. From BofA: “Total card spending per HH was up 0.7% y/y in the week ending Nov 11, according to BAC aggregated credit and debit card data. Total spending per HH ex gas increased 1.4% y/y, while retail ex autos was down 1.1% y/y in the week ending Nov 11. Relative to October, y/y spending trends have improved modestly in November so far.”

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Unemployment claims rise. Initial claims for unemployment benefits increased to 231,000 during the week ending November 11, up from 217,000 the week prior. While this is up from a September 2022 low of 182,000, it continues to trend at levels associated with economic growth.

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New cars are becoming more affordable. From Cox Automotive: “Income growth favored consumers enough in October to offset the impact of higher prices, lower incentives, and higher auto loan rates. New-vehicle affordability improved slightly month over month and year over year, according to the Cox Automotive/Moody’s Analytics Vehicle Affordability Index. … The typical payment increased by 0.2%, but the number of median weeks of income needed to purchase the average new vehicle declined to 38.6 weeks from a downwardly revised 38.7 weeks in September. At 38.6, it was lower than the 40.1 weeks recorded last October.”

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Used car prices are coming down. From Manheim: “Wholesale used-vehicle prices (on a mix-, mileage-, and seasonally adjusted basis) decreased 1.6% from October in the first 15 days of November. The mid-month Manheim Used Vehicle Value Index declined to 206.1, which was down 5.3% from the full month of November 2022.”

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Mortgage rates decline. According to Freddie Mac, the average 30-year fixed-rate mortgage fell to 7.44%. From Freddie Mac: “For the third straight week, mortgage rates trended down, as new data indicates that inflationary pressures are receding. The combination of continued economic strength, lower inflation and lower mortgage rates should likely bring more potential homebuyers into the market.”

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Many own their homes outright. From Bloomberg: “There’s talk of a great divide in the U.S. housing market, as new buyers get crushed by 8% mortgage rates while earlier ones cling gratefully to loans of less than 3%. Missing from this story is a third, even more fortunate group: the rapidly growing number of Americans who own their homes outright. The share of US homes that are mortgage-free jumped 5 percentage points from 2012 to 2022, to a record just shy of 40%.”

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New home construction ticks up. Housing starts rose 1.9% in October to an annualized rate of 1.37 million units, according to the Census Bureau. Building permits climbed 1.1% to an annualized rate of 1.49 million units.

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Home builder sentiment is in the dumps. From the NAHB’s Alicia Huey: “The rise in interest rates since the end of August has dampened builder views of market conditions, as a large number of prospective buyers were priced out of the market. … Moreover, higher short-term interest rates have increased the cost of financing for home builders and land developers, adding another headwind for housing supply in a market low on resale inventory.”

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Offices are still very empty. From Kastle Systems: “Office occupancy hit a new pandemic record high last week. Kastle’s 10-city Back to Work Barometer rose nine tenths of a point to 50.5%, surpassing September’s record high of 50.4% occupancy. The rise was led by Chicago, which rose three full points to 55%, and San Francisco, which rose 2.1 points to 44% occupancy. New York City rose 1.6 points to 50.5% occupancy, matching its previous pandemic high in June.”

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Small business finances are healthy. From BofA: “…small business net worth has surged during the last few years, meaning that even with the rise in credit card debt, the ratio of debt to net worth remains at historically low levels. This can be seen in Exhibit 3, which shows the ratio between total bank loans, including credit card loans, and net worth for nonfinancial noncorporate businesses – most of which are small businesses.

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Small business optimism ticks lower. The NFIB’s Small Business Optimism Index ticked lower in October.

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Importantly, the more tangible “hard” components of the index continue to hold up much better than the more sentiment-oriented “soft” components.

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Keep in mind that during times of stress, soft data tends to be more exaggerated than actual hard data.

The entrepreneurial spirit is alive. Monthly small business applications remain well above prepandemic levels. From the Census Bureau: “October 2023 Business Applications were 472,993, virtually unchanged (seasonally adjusted) from September. Of those, 154,153 were High-Propensity Business Applications.”

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Industrial activity slips. Industrial production activity in October fell 0.4% from September levels, with manufacturing output falling 0.7%.

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From JPMorgan: “The October drop in activity should be viewed as largely temporary, as strikes helped push motor vehicle and parts output down 10.0% during the month. That said, things weren’t great away from the auto sector, with output for manufacturing ex. motor vehicles and parts up only a modest 0.1%.”

Near-term GDP growth estimates remain positive. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.1% rate in Q4.

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Putting it all together

We continue to get evidence that we could see a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.

This comes as the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to bring inflation down. While it’s true that the Fed has taken a less hawkish tone in 2023 than in 2022, and that most economists agree that the final interest rate hike of the cycle has either already happened or is near, inflation still has to cool more and stay cool for a little while before the central bank is comfortable with price stability.

So we should expect the central bank to keep monetary policy tight, which means we should be prepared for tight financial conditions (e.g., higher interest rates, tighter lending standards, and lower stock valuations) to linger. All this means monetary policy will be unfriendly to markets for the time being, and the risk the economy slips into a recession will be relatively elevated.

At the same time, we also know that stocks are discounting mechanisms — meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.

Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs, and those with jobs are getting raises.

Similarly, business finances are healthy as many corporations locked in low interest rates on their debt in recent years. Even as the threat of higher debt servicing costs looms, elevated profit margins give corporations room to absorb higher costs.

At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.

And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.

Note: A version of this article was originally published on TKer.co.

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