07.27.2022 The Fed is poised to ratchet rates up again this afternoon. If they tighten 75bps, which is widely expected, that will represent the most aggressive back-to-back tightening since Paul Volcker’s Fed in his early 1980s inflation battle. Investors are confident that Powell & Company’s monetary moves will push inflation lower. In fact, Fed Funds futures anticipates rate cuts next year. At 9.1 per cent, June’s year-over-year CPI reading is uncomfortably high relative to the S&P 500’s current price/earnings ratio. Persistently high inflation would push short-term interest rates higher, increase the likelihood of recession and weigh on earnings growth and valuations. Not a rosy scenario.
We see increasing evidence, however, that CPI peaked in June, and July could offer incremental relief. Food and energy prices, which had an outsized influence in recent price data, are coming off the boil, according to current commodity markets. It’s comforting to see that, with the exception of natural gas, many food and energy prices abated in July. The national average price of a gallon of unleaded gasoline is $4.30, down from $4.84 on June 30, according to the American Automobile Association. Wheat, corn and soybeans, key ingredients in much of the food we eat, are off double digits. While beef prices rose more than six per cent for the month, pork is off more than 10 per cent.
We also see growing evidence that consumers’ willingness and ability to spend is getting tired. While wages are rising, wage gains have failed to keep pace with inflation over the last year, eroding purchasing power. Wages rose 5.1 per cent year over year through June, although “real” wage gains were negative 3.6 per cent over the last 12 months. Recent reports from Walmart and Target confirm that shoppers are increasingly price sensitive, sticking to staples and shying away from higher-margin, discretionary purchases. Retail inventories are burgeoning, paving the way for discounting. Moreover, households appear to have spent through their pandemic-supported cash hoard, as evidenced by a recent runup in credit card debt and AT&T’s acknowledgement that an increasing number of their customers’ bills are past due.
While all eyes will be on the Fed this afternoon, the real show takes place August 10 at 8:30 ET, when the Bureau of Labor Statistics releases July CPI. We, and the market, are betting on a weaker number