Last week the U.S. Bureau of Labor Statistics released the latest reading of the consumer price index, one of America’s main measures of inflation. The milestone report showed a continuation of a year-long decline in the rate of inflation.The consumer price index, or CPI, rose just 0.2% in the month of June, up 2.97% from June 2022. The biggest contributors to inflation were a 16.7% decline in energy prices since last year, a modest decline in the price of medical care services and used cars, and restrained growth in other categories such as food and apparel.A slowdown in the CPI represents a massive stride toward stability for the U.S. economy. However, the CPI’s momentum might not be enough to satiate bank chairs at the Federal Reserve, which embarked on a campaign in March 2022 to curb rising prices by raising interest rates. That effort, intended to cool the economy, has resulted in the Federal Reserve raising rates at 10 consecutive meetings. Headline interest rates now sit north of 5%, and by many measures, inflation is inching closer to that 2% target.The last mile to reaching that target might prove to be the hardest, though.
The Federal Reserve’s emphasis on other markers of inflation, particularly personal consumption expenditures (PCE), a measure of inflation sourced from businesses, might mean more interest rate hikes could be necessary to get to 2%. However, another increasingly popular measure of inflation which captures the Fed’s preferred flavor of inflation has gained clout in central banks and analyst circles for its emphasis on a “slimmer set of prices that remain stubbornly high.” It’s called supercore inflation, and it parses out the price of volatile components like shelter and energy, and hones in on inflation in services offered by businesses like photo studios, tax preparers, and restaurants. As a result, supercore has gained a reputation for being a more ‘on the ground’ measure of inflation in the economy (and perhaps an indicator of how stubborn it is.)
Thankfully, supercore has shown big declines like other popular measures—and that could be a great thing for the markets. In June 2023, supercore was up 2.7% year-over-year. And by comparison, wage growth was 4.4% year-over-year, which means the average American is regaining buying power against pesky prices.
There’s signs that consumers are already feeling the impact. Morning Consult’s U.S. Consumer Confidence Dashboard shows that optimism around the economy has risen sharply among consumers from a year ago, during which inflation hit its 44-year high. Even once-skeptical analysts are also singing a more positive tune, perhaps in part because the first half of the year was extremely kind to markets: the S&P 500 (@SPX) rose over 17%. Its tech-heavy counterpart, the Nasdaq-100, rose over 38%. The recovery in stocks has led many banks to revise their year-end price targets for major stocks and indexes upward.That might be surprising considering the high sticker price for stocks, which only a year ago were pummeled given concerns about earnings quality. But with interest rates believed to be near the top of the curve and recession fears starting to subside, the markets might be in a rare place to continue its upward rally.
The odds of more Fed hikes will decline with inflation, which means that short-term interest rates will likely fall, creating a condition known as a Bull Steepener. This condition is generally positive for the value of stocks and bonds because it compresses yields on short-term bonds. This makes investors more optimistic about the economy, and consequently, more bullish about stocks and other investments.Of course, falling interest rates are not a guarantee that stocks and bonds and real estate values will rise again. There are structural factors which affect every market, and particularly in the stock market, the value of many stocks is rich compared to historical patterns. As of July 14, 2023, the S&P 500’s P/E ratio is 26x, which was higher than its lifetime mean of 16x.
The Nasdaq-100, which has a concentration of growth-oriented tech names and staples, was even higher at 30x.
However, with suggestions that interest rates are approaching their apex, recession fears and economic anxieties are beginning to subside. If supercore inflation is any indication, the case for further market upside looks stronger than the alternative.
On the date of publication, Noah Weidner did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
