'Disinflationary Wave Is Building' Even As Investors Anticipate Aggressive Fed Rate Hike, This Economist Says

‘Disinflationary Wave Is Building’ Even As Investors Anticipate Aggressive Fed Rate Hike, This Economist Says

Signs of disinflation have emerged even as investors fear Federal Reserve Chairman Powell and his colleagues are continuing to fight inflation through aggressive rate hikes that have hit both stocks and bonds, according to a recent report. Capital Economics note.

While it looks like the Fed may announce on Wednesday that it will raise its benchmark rate by three-quarters of a percentage point for the third time in a row, Paul Ashworth, chief North America economist at Capital Economics, expects a monetary policy stance to follow soon. less aggressive.

“If we are correct that inflation will recede soon, officials will quickly switch to much smaller increases,” he said in a note on Tuesday. “The continued decline in gas prices and the decline in food inflation will weigh on the headline CPI over the next month or two,” he said, referring to the consumer price index. He also pointed to signs of disinflation in the core CPI data, which excludes energy and food.

“Despite the larger-than-expected 0.6% rise in core prices in August, there are also growing signs of disinflation,” he wrote. Supply shortages have normalized, with the company’s commodity shortage gauge now suggesting “commodity inflation could fall back to 2% before the end of the year, from 7% in August,” according to Ashworth. .

CAPITAL ECONOMY NOTE DATED SEPT. 20, 2022

The Federal Reserve aims to bring inflation down to its 2% target range through monetary tightening that began earlier this year, crushing stocks and bonds.

The US stock market closed lower on Tuesday as investors await clues on the Fed’s future path to hike rates after it concludes its two-day policy meeting on Wednesday.

The Dow Jones Industrial Average DJIA,
-1.01%
fell 1% on Tuesday, while the S&P 500 SPX,
-1.13%
fell 1.1% and the Nasdaq Composite COMP,
-0.95%
it fell nearly 1%, according to data from FactSet.

The fed funds rate is in a range of 2.25% to 2.5% ahead of the central bank’s anticipated rate hike on Wednesday. Fed funds futures suggest the rate may top out near 4.5%, according to the Capital Economics note.

“Those expectations are above our own forecasts, mainly because we expect inflation to recede more sharply,” Ashworth said. Utility inflation is being driven by rapidly rising rents, “but the latest private sector measures suggest new lease inflation is slowing markedly,” she said.

In his opinion, a “disinflationary wave” is taking shape.

“There are broader signs of deflation in services, from falling airfares to hotel rates, while falling long-term inflation expectations have markedly reduced the risks of a wage-price spiral,” he said. . “The upshot is that we expect to see clearer and more convincing signs of falling inflation in the CPI numbers soon.”

Meanwhile, higher real yields are weighing on equity prices and pushing corporate bond spreads higher, his note shows.

For example, the ICE BofA US High Yield Index Option-Adjusted Spread index was 4.88 percentage points over comparable Treasuries on Monday, down from 4.2 percentage points on Aug. 11, according to data from the Treasury’s website. Federal Reserve Bank of St. Louis.

iShares Boxx $ High Yield Corporate Bond ETF HYG Stock,
-1.02%
it fell about 1% on Tuesday, FactSet data shows. The fund has lost 11.6% this year on a total return basis through Monday.

Watch: Why rising Treasury yields are plaguing the stock market ahead of the Fed’s next rate hike

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