The Fed’s inflation problem has not disappeared due to one ‘positive’ CPI reading. There have been many premature declarations of a ‘pivot’. A single reading does not make a trend and should never be viewed in isolation.
But the October CPI report takes on added significance when considered in a broader context: 1) the Fed’s preferred measure of inflation has been undershooting the CPI by some margin; 2) the global trade cycle has turned; 3) the Chinese PPI is in deflation; 4) the housing data in the US continue to worsen; and 5) technology companies are entering a period of rationalisation, cutting jobs.
Durables deflation is now a distinct possibility for 2023, and housing components of the CPI are set to roll over.
The conditions may be in place for the Fed ‘pivot’ narrative to gain traction and spur a year-end stock market rally between now and the start of 2023, potentially sending the S&P 500 to 4,200.
In 2023, the direction for the S&P 500 will depend on the credit cycle, and whether disinflation becomes a deflationary bust.
Even if the Fed ‘only’ does 50 and 25 at its next two meetings, and then pauses, the US economy may still be sitting on a federal funds rate of 4.75% for some time. This level of the federal funds rate still has the potential to expose over-leveraged areas of the economy in 2023. Reverse yield gaps (both nominal and real) suggest the stock market is still expensive relative to US Treasuries.
Nevertheless, the reality of disinflation (falling profit margins) and tightening credit standards (e.g., latest Senior Loan Officer Survey), may not hit home until the next set of earnings reports.
