US inflation news will remain a hot topic for the stock market for several months now. The reason for that is the debate over the fact whether inflation has hit the peak or may still show a spike in the months ahead. While that may not look plausible now, the way the equity market is reacting, it seems the peak is done. The US stock market was up by nearly 5% over the last 5 days leading up to the US CPI data release on September 13.
Exceeding expectations, U.S. inflation figures for August have opened the door for the Federal Reserve to raise interest rates significantly when its policymakers convene next week. The consumer price index increased 0.1% in August and was up 8.3% from a year ago, according to data released on Tuesday.
From 8.6% in May, US inflation rose to 9.1% in June and later fell to 8.5% in July. US CPI data is expected to show a declining trend but the core inflation may still be a concern with economists, analysts, and stock market investors. “ The FED is particularly concerned with core categories as continued price pressures pose the risk of inflation becoming increasingly entrenched in the economy as well as in people and firm psychology, affecting behaviors,” says José Torres, Senior Economist, Interactive Brokers.
Fed rate hikes are aimed to bring down inflation levels to under 2% but that requires crushing new job openings and seeing rising unemployment. “FED tightening has contributed to price decreases in goods and commodities through demand declines, but services and rent are much more resistant and will require further increases in the unemployment rate to cool off,” adds Torres.
The markets will be looking for clues as to how high the Fed could hike rates before calling it a day. “August’s inflation reading will not deter the FED from their tightening plans as they remain committed to easing price pressures. Liquidity withdrawals and interest rate hikes will continue into 2023 with the terminal rate topping out at 4.28 percent. The 10-year treasury yield will likely rise above 3.6% in the coming months,” says Torres.
The real impact on the stock market from the August inflation numbers will be interesting to be seen. “While the equity market may cheer another reduction in headline inflation, rising core prices, a weak seasonal period, rising yields and overbought conditions in the short-term suggest a bearish response. The market is more likely to view this report through a bearish lens as FED hawkishness and rising yields become the primary focus,” says Torres.
The US market has been declining since January 2022, with the exception of July, when the markets bounced. Uncontrolled inflation is bad for the economy, thus the central bank had to intervene by boosting interest rates. The Fed has already increased rates by 225 basis points, and more increases are expected.
While the high valuations that the stocks enjoyed earlier have come down, it hasn’t bottomed out yet. Any negative surprise in inflation data or a sudden change in macroeconomic factors may initiate the next leg of the downtrend in the market. It is better to be diversified and keep adding quality stocks with a long-term view.