More Positive Inflation News Drives Market Rally

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

The markets had a strong week as investors celebrated positive indications on inflation and consumer sentiment. Wednesday’s Consumer Price Index (CPI) came in lower than analysts anticipated, staying flat in the month of July, decelerating year-over-year inflation from 9.1 percent to 8.5 percent. As we have been expecting, this month’s reading is a key sign that inflationary pressures are subsiding, which could give the Fed room to take a softer approach on future rate increases.

Meanwhile, on Friday, the University of Michigan’s preliminary report on August consumer sentiment showed that expectations for one-year inflation pulled back and that consumers expect inflation to stay well controlled in the next 5 to 10 years. The year-ahead inflation expectations fell to 5 percent, the lowest reading since February. Long-term inflation expectations came in at 3 percent, within the range we’ve seen most the past year. It’s noteworthy that long-term inflation expectations remain anchored and are not moving higher because inflation expectations play a key role in shaping future inflation readings, and these data points are moving in the right direction.

These reports continue to build our confidence that inflation will continue subsiding in the coming quarters, which will give the Feds wiggle room on future rate hikes.

Wall Street wrap

While CPI and the consumer sentiment survey took center stage this week, other key reports also indicate cooling inflation as well as an economy that continues to transition its appetite for consumption from goods to services.

More good news on inflation. There’s more evidence that the supply chain disruptions that initially caused inflation are easing and may even be reversing. The U.S. Census Bureau’s Wholesale Inventory report out Wednesday showed that inventories rose 1.8 percent in June and are up 25.5 percent year-over-year. These inventory levels, against a backdrop of moderating demand due to consumers shifting their dollars from goods to services, will ultimately put downward pressure on goods prices and help push overall inflation lower.

Wholesale prices fall, another sign of easing inflation. Along with the build in inventories, Thursday’s Producer Price Index fell 0.5 percent, while analysts were expecting a 0.2 percent increase. This is the first time in two years that the index has fallen. While it will take time, ultimately falling wholesale prices should trickle down to the prices consumers are paying.

The small business environment is improving slowly. The Small Business Optimism Index edged up from a nine-year low, to 89.9 from 89.5. Despite last week’s positive news on inflation, it continues to be small business owners’ single biggest challenge. However, inflation data in the report inched in the right direction. The net share of owners raising prices fell 7 points to a net of 56 percent, while the percentage expecting to raise prices in the next three months fell from 49 percent to 37 percent and is off significantly since its all-time high of 53 percent hit last November.

The report also shows that small businesses are having an easier time finding workers, albeit only slightly easier. Forty-nine percent of business owners reported job postings that could not be filled in July, down 1 percent from June. While the current compensation index remained steady at 48 percent, owners’ compensation plans for the next three months continued its downward trend at 25 percent, off from last month’s 28 percent and the all-time high of 32 percent hit last December.

The week ahead

• Monday: By mid-morning the National Association of Home Builders (NAHB) will release its Housing Market Index (HMI). Given falling demand, we expect to see housing prices moderate, which will filter into CPI data in the coming quarter.
• Tuesday: We will get July housing starts and building permits from the U.S. Census Bureau as well as July’s Industrial Production report from the Federal Reserve.
• Wednesday: Before the opening bell, the U.S. Census Bureau will release its Retail Sales report. Here, we will see how consumer spending is holding up in the face of falling (but still high) inflation.
• Thursday: The Conference Board’s Leading Economic Index (LEI) survey, a key release for the week, will come out at 10 a.m. These key indicators will show us where the economy is headed in the coming months.

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