A Direction Change For US Inflation?

Week Ending 11th November, 2022

In this week’s update - US inflation October print was lower than expected with signs emerging of a change in direction of inflation. However, this is by no means confirmation of what is to come. The US midterm elections are round the corner, but who’s likely to come out on top? In the markets, both Equities and Bonds had something to cheer about.

Continue reading for the full weekly update:

US Inflation Print:

October inflation was a much lower-than-expected print at both headline and core (headline minus food & energy) levels. It was generally broad-based too which made it all the more welcome and meaningful. It understandably gave the Fed - and markets - something to cheer about. Both Bonds and Equities soared on the day with the S&P 500 closing +5.45% while the US 10y Treasury yield fell 0.33% i.e. bond prices soared. It was a similar trend across most markets.

So, what should one make of this? Looking at the detail, there were price declines in Utility (piped) gas services (-4.6% m/m), Used cars / trucks (-2.4% m/m) and Medical care services (-0.6% m/m). These account for 1%, 4.5% and 8.5% of the inflation basket respectively and explain approximately -0.20% of the movement between this and the last reading. A push by the Biden Administration, to cap medical costs, has proved timely ahead of the recent midterm elections. Two further measures of inflation closely watched by the Fed - the trimmed mean and the sticky price – both suggest a change in direction but are by no means confirmation.

Market reaction is easily explainable – a (huge) relief rally exacerbated by short covering. Why? The perception that there will be a change in direction with respect to interest rates. I think this is very premature. The rally seen in the 10y exceeded those following Long Term Capital Management (LTCM) demise and 9/11. December futures are predicting an 85% probability of a 0.50% rate hike – which sounded about right even before the CPI print towards the end of last week. The effect of all this extended well beyond the US into other markets. It was classic “Risk-On” with the US$ selling off heavily and everything else rallying: Non-US$ FX, non-DM Equities, EMD, EM Equities, Commodities.

As the old saying goes: one swallow doesn’t make a summer. Realistically, we need two more inflation prints for clarity. The December print is Christmas time and the January print is New Year sales time. One key factor in favour of inflation having turned are manufacturing prices. The index has dropped from 92.1 to 46.6 with most manufacturers saying prices are not increasing. The slowdown in China boosts the case for export deflation coupled with the same from other EM nations. Meanwhile, continued demand compression, by consumers cutting back, puts retail pricing under pressure. Another indicator is the global shipping industry which is reporting too many containers! The latter is being driven by a decline in global consumption as opposed to a normalisation to pre-covid. Cancellations are rising, depots filling up and freight rates are falling. However, all the above does not mean inflation is solved.

US Midterm Election outcome:

The Red (Republican) wave never materialised. Counting is still underway in some of the most closely contested seats. In the battle for the Senate, Georgia has gone to a runoff. At the latest count, Republicans lead 49 to 48 for the Senate while for the House of Reps, Republicans lead 211 to 196. What went wrong? Essentially two factors – Abortion and the Trump factor.

On abortion, Democrat campaign tactics paid off - they realised there was not much more they could say or do over inflation and its impact on the cost of living so instead they threw their plentiful campaign cash into ads mostly about the abortion debate. In key Senate races where it was supposed to be really tight, the Democrats romped home. It wasn’t widespread but it was very targeted – and that’s all that matters when it comes to the most vital seats. For the Senate, it’s down to Georgia, Nevada and Arizona. If the Democrat incumbents in Nevada and Arizona hang on, then they retain overall control. Georgia is really close and has gone to a runoff. Whatever happens, the Republicans have made hard work of it all. It was theirs to lose – and they might!

The other issue was Trump himself! Trump stuck the Republicans with bad candidates and bad legacy issues that go back to the last election. With a few exceptions, candidates he endorsed fared poorly while those not on his “approved” list did well. One big performer was Ron DeSantis in Florida who is believed to be preparing to accept the Republican nomination for President. Trump has said he will make a big announcement on the 15th. I can’t wait to hear that especially given how things have gone.

Whatever the outcome, you get the feeling the stars have turned in favour of Biden – who wants to stand again. There are two years left – that’s a long time in politics. If the above inflation news really proves to be a turning point, that’s a game-changer. The economy is always a game-changer. Furthermore, if Trump stands unopposed, the Republicans are doomed – these midterms proved that with his choice of candidates. If DeSantis stands up against him, the Republicans become split. I can’t help thinking this is the end of Trump as we know it.

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