For the past three years, the markets have been haunted by a particularly ghastly boogeyman – inflation. However, today’s Personal Consumption Expenditures (PCE) report suggests that boogeyman has been officially vanquished. With inflation normalized, the trajectory for stocks appears to be an upward ascent to record highs.
Indeed, this morning’s inflation data revealed that the Federal Reserve’s preferred inflation metric – the PCE price index – rose just 2.2% year-over-year in August.
That’s quite remarkable.
Two years ago, in the summer of 2022, PCE inflation was soaring above 7%, its highest rate since 1981. Now, it’s only slightly above the Fed’s 2% target and within its customary ‘normal’ range. Furthermore, September’s inflation projections stand at a modest 2%.
In essence, inflation has normalized and aligned with the Federal Reserve’s target levels.
This turn of events is undeniably bullish.
The U.S. economy has encountered significant challenges due to persistent high inflation over the past three years, leading the Fed to combat it through interest rate hikes. This action drove up borrowing costs across various sectors, including housing and automotive, resulting in substantial market stagnation.
However, the tide is turning as the Fed embarks on a path of interest rate reductions. Just a fortnight ago, it slashed rates for the first time since the Covid-induced crash in March 2020. Notably, this cut amounted to 50 basis points (compared to the usual 25 basis points), and the Fed has indicated a continued downward trajectory for rates over the next couple of years. Post the initial cut, several Fed officials have reiterated the necessity for ongoing rate reductions to bolster the economy.
The message from the Fed is crystal clear. It stands prepared to support the U.S. economy by maintaining consistent rates, provided that inflation remains in check.
Consequently, the potential resurgence of inflation represents the primary risk to the current U.S. economic landscape. As long as inflation remains subdued, the Fed will persist with rate cuts, bolstering signs of economic recovery and propelling stocks to new heights.
Ensuring that reinflation remains at bay is imperative.
Hence, the latest inflation report carries a bullish undertone. The PCE inflation rate slipped from 2.5% in July to 2.2% in August, with expectations pointing towards a further decline to around 2% in September.
Inflation continues to trend downwards. Furthermore, external factors, particularly the evolving situation in Saudi Arabia, are likely to contribute to this ongoing descent.
Analyzing Oil’s Trajectory
Oil plays a pivotal role in the global economy, serving as a fundamental input across various industries worldwide. Consequently, fluctuations in oil prices exert a significant influence on overall prices, including inflation levels. Historically, when oil prices surge, inflation tends to follow suit, and vice versa when oil prices dwindle.
Presently, oil prices are witnessing a significant downturn. Prices have plummeted by approximately 10% over the past month, with figures standing more than 20% below their early 2024 peaks and over 30% from their late 2023 highs. Essentially, oil is currently trading at levels reminiscent of a three-year low.
