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Mission Accomplished For the Fed: A Slowing Economy

A component of last Friday’s inflation report came in higher than we had expected. The CPI headline number increased to its highest level in 40 years. However, that was only part of the story. The core inflation rate, excluding food and energy prices, actually posted a downtick for the third consecutive month. That was matched this week by a third straight downtick in wholesale price growth as expressed by the core PPI (Producer Price Index) number. However, the headline inflation number prompted the Fed to hike the Fed Funds rate by 75bp rather than the 50bp we had expected. The culprit? Energy (diesel/gasoline) prices that, at present, show no sign of easing.

Mortgage rates briefly breached the 6% threshold this week and early indications are that the sellers’ market in housing is coming to an end. It also appears auto sales peaked in April, explaining the moderating Retail Sales data we saw this week. Industrial Production is slowing and manufacturing survey expectations have dipped into negative territory. All point to a slowing growth rate for the US economy. That’s the desired effect of the Fed’s shift in monetary policy and we should see more evidence of that over the next several months. Sadly, none of what the Fed has accomplished solves the supply chain problem. The solution there lies beyond the scope of the FOMC’s influence and what we’re hearing from fiscal policy-makers holds little promise of addressing that issue.

The market initially greeted the Fed’s interest rate decision with a mild rally on Wednesday. That gave way to yesterday’s crescendo of selling that hinted of capitulation by the bearish crowd. Much as the cure for high prices is high prices when it comes to inflation, the cure for low stock prices is low stock prices. We saw an overshoot to the upside in stock valuations at the end of last year. We believe we’re seeing its inverse now. For the under-invested, the market is littered with too many bargains to ignore. It appears stocks have priced in a recession that may occur. The risk for investors is that Energy will continue to drive headline CPI higher and inspire the Fed to slam the brakes on the economy while the supply chain constraints persist. We currently see that as only a remote possibility.

For now, we’re content to see the Fed frontload larger rate increases now to buy time to see the full effect of its plan to shrink its balance sheet and, consequently, the money supply that’s fueling inflation. We believe Peak Housing has been achieved as well as Peak Core Inflation. We believe the Fed has accomplished its mission. What remains is putting Peak Energy in the rear-view mirror and lowering headline CPI. Achieving that is in the hands of the administration and Congress. Stay tuned.

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