US rising inflation looks to have peaked.

There were three big market-moving stories last week: the US midterm elections, the latest crash in the unregulated world of crypto currencies, and the release of US inflation data for October. By Friday, it was the lower-than-expected inflation data that dominated in terms of market activity.

Thursday’s report from the Bureau of Labor Statistics revealed annual consumer price index (CPI) inflation slowed to 7.7% in October, below the 8% expected by most economists, and the lowest level since January. This was a very good piece of news and better than expected.

For the first time this year it looks as if US inflation has peaked and now declining. While it is still too early to assume the US Federal Reserve will pivot away from its monetary tightening policy, but the market euphoria following the data release was quite something. Not since the market confusion in the early days of the COVID pandemic have we witnessed so much movement in both equity and bond markets. Observers could have got the impression that all 2022 dominating market trends had reversed: the tech-led Nasdaq gained 7.5% and US Treasuries rallied as yields of 5 year to maturity bonds fell 0.3%. While we may not have reached the actual turning point in terms of turning market and economic tides, perhaps last week’s activity confirms that there is a widespread belief in markets that the current economic downturn is more likely to be shorter and shallower than some scaremongers including the Andrew Bailey, the Governor of the Bank of England, would like to suggest.

What has led to the slight decline in US consumer price inflation is a reversal of the price of goods. Supply chain disruptions have largely disappeared as time has allowed production processes to realign themselves. Freight prices have normalised, and China has once again become an exporter of disinflation.

This is good news indeed for shoppers, especially with Christmas approaching, but is clearly no longer the primary focus of central banks, which as we laid out here before, are much more concerned about secondary inflationary pressures, namely tight labour markets leading to wage inflation.

Expectations that Fed Chair Jerome Powell will get more dovish are premature until labour markets ease. Should the Fed raise rates at its December meeting by less than the a 0.75% as they have in their last two meetings, Fed members may as well tell markets that they are indeed pivoting. So, it is likely and even probable that external cost pressures in the overall inflation dynamics will be easing over the coming weeks and months (goods prices in the US and energy prices in Europe), but that is not yet sufficient to realistically expect central banks to take their foot off the monetary brakes.

The Fed’s December meeting may well cause yet another turn in market sentiment and the underlying corporate profit development, coupled with thinning seasonal liquidity from institutional investors, leaves us facing some more potential volatility before the year ends. However, the outlook for asset markets over the near term into 2023 is certainly getting better.

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