Proof Positive or Not? The Fed, Rate Hikes and Disinflation

Daniel Hawley |

Has the inflation tide turned? Core CPI was forecast to increase 0.3% month-over-month and 6.1% for the year but came in recently at 0.2% and 6% respectively. Food on the other hand (which is not part of Core CPI) has continued to rise as have the costs of shelter.

In the bond market, long-term Treasury yields are starting to fall. Analysts are projecting that these will continue to fall into 2023. The 10-Year Treasury yield topped out at 4.3% a few weeks ago and finished at 3.49% a few days ago, down more than 80 basis points from its peak.

Also of note: The U.S. ISM Manufacturing PMI has declined over the last few months into territory below 50 which signals falling demand. Each time the index has fallen below 50 - over the past 50 years - the 10-Year Treasury yield has proceeded to fall over the following few quarters, notably this also occurred during the era of high inflation of the 1970's. Falling treasury yields have an inverse correlation in the past with higher risk beta stocks rising

Historically leading indicators of employment are also pointing down. The Conference Board’s "Leading Economic Indicators" index for example peaked in April 2021 and has been declining for the past 19 months. It is now in negative territory. Each time this index has sunk into negative territory over the past 70 years, it has led to a labor market contraction. The typical time lag is between 18 and 24 months. As the LEI index peaked 19 months ago, if 70 years of historic data remain true today (for which there no guarrantees), one could expect to see declining job counts between now and April 2023. 

While the data suggests progress is being made on the inflation front, it is not conclusive. While the Federal reserve has indicated it may be less aggressive with its size of rate hikes going forward, it will nonetheless continue to see the job through. A recession whether it is shallow or more prolonged would dampen demand. However, as already mentioned, we have yet to see any meaningful reduction in the costs of shelter or food. While analysts are focused on a declining trend in inflation data and consumer demand, bringing inflation into the Fed's orbit of less than 2% per annum may prove more challenging that any economist or analyst is willing to consider just yet.

A cautious stance is warranted until the trend in the data is more conclusive. The Federal Reserve may move more cautiously but one should not mistake caution with their resolve to do whatever it takes to turn the tide of inflation.

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