Thursday, September, 15, 2022
Stocks fell sharply on Tuesday after a key August inflation report came in hotter than expected, hurting investor optimism.
The Dow Jones Industrial Average slid 1,276.37 points or 3.94%, to close at 31,104.97. The S&P 500 dropped 4.32% to 3,932.69 and the Nasdaq Composite declined 5.16% to end the day at 11,633.57.
While it was the worst drop for the Dow since June 2020, the drop only erased 5 days of recent gains, pulling the S&P 500 back toward its Sept. 6th close of 3,908.
Inflation Cools But Not Enough
The August Consumer Price Index (CPI) rose 8.3% year-over-year (YoY), which is slightly down from 8.5% in July. Excluding food and energy, the core CPI rose 6.3% (YoY), accelerating from last month. Inflation pressures continue to ease in a few categories such as gasoline, airfare and used vehicles. However, several categories are still running hot.
Food prices rose 11.4% from a year ago, the largest year-over-year increase since 1979 and electricity prices increased 1.5% month-over-month, the fourth consecutive increase. Yearly electricity prices rose the largest since August 1981.
As shown in the chart below, the latest inflation report is sending mixed messages. “Headline inflation is slowly easing, but rising food and shelter costs put acute pressure on U.S. consumers,” explained Jeffrey Roach, Chief Economist for LPL Financial. The Personal Consumption Expenditure (PCE) price deflator - the Federal Reserve’s (Fed) preferred inflation gauge - will likely show a slower rate of inflation since imputed housing costs have a smaller impact.
Impacts on Consumers
Declining prices at the pump could support consumer confidence in the near term, however, rising electricity and natural gas prices will put a damper on the consumer outlook as we move into the winter season. The U.S. does not have an energy crisis like Europe, however, the impact of higher energy bills will likely affect consumer spending in the upcoming cooler months.
Rising food costs are a growing concern. Inflation pressures are especially hurting lower income households who spend a greater percentage of income on food.
Rising Rents Continue
Rents will likely continue to rise as long as a tight housing market keeps would-be buyers away. Rent prices are up 6.7% (YoY), the fastest rate since the early 1980s. The booming housing market explains most of the rise in rental costs. During the recent period of unusually low mortgage rates, housing demand skyrocketed and home price appreciation reached new levels. High housing costs pushed many homes out of reach for would-be millennial buyers and for first-time buyers with no pre-existing home equity. High demand for homes and low supply created insurmountable hurdles and pushed many to be renters instead of home buyers.
Fed Will Probably Hike 75 Basis Points
The Fed still has work to do and will likely increase rates again by 75 basis points later this month as core inflation is not cooling as fast as expected.
As import prices due to the strong dollar and producer prices ease, the inflation outlook should improve. As policy makers have publicly indicated, inflation is the primary concern and for now, the Fed is willing to sacrifice economic growth in the near-term to get inflation back to the long-run growth rate of 2%.
Investors and policymakers know inflation will likely stay above target for a while. As mentioned earlier, The Federal Reserve’s preferred inflation gauge is the Personal Consumption Expenditure (PCE) deflator. The Fed prefers the PCE deflator metric because the CPI does not account for product substitutions consumers make when prices change, whereas, the PCE deflator tracks price changes of actual consumer purchases. The August PCE deflator will be released on September 30.
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References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
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The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
All index data from FactSet and MarketWatch.
This Research material was prepared by LPL Financial, LLC.