Inflation mildly better, markets roar

US inflation came in lower than expected overnight. Markets roared higher.

It was a little better than last month. It was better than expectations. It wasn’t a fantastic result, but it seems markets didn’t need that. See the tables below:

 Food inflation

Energy Inflation

Goods Inflation

Services Inflation

 

Given some technicalities in calculating rent inflation, services inflation is unlikely to decline quickly.  

How should we look at inflation reversion?

There are two ways to consider reversion:

1. While central banks will force inflation back to 2%, prices will remain structurally higher. 

2. Prices have been temporarily shocked, but will return to the prior trend 

Goods are probably more likely to be in the second category, services more likely to be in the first. Given the Ukraine war, gas prices are likely to be in the first category. Oil is more transportable, and so probably has a chance for either. 

The shape of future inflation or deflation depends on how many things you think will fit into each profile.

Going forward

The way the maths are at the moment, annual inflation is going to remain high for some time. If inflation went immediately to a 2%p.a. rate, by March next year both core and headline inflation would still be above 4.5%:

Inflation paths

Say you were expecting imminent deflation in many categories. If the US started printing -0.7% per month inflation every month from November, annualised inflation would still be above 2% until March 2023. 

Deflation path   

It was a fascinating reaction by markets, celebrating a mildly better, but still bad inflation report with a 5% rally. My expectation is still that central banks want to jump up and down a few times on the corpse of inflation to make sure that it is truly dead before reversing course. With that in mind, I’m expecting very low inflation or deflation by mid-2023. But, even with that expectation, the headline annual inflation figure will stay high for at least six months.

Will markets celebrate inflation falling over the next few months the same way? If so buy equities now. Or is this a buy the rumor of lower inflation, sell the fact as earnings get hit by weaker demand? If so sell.