This morning, the market’s preferred inflation report – October’s all-important Consumer Price Index (CPI) data – was released. And it confirmed that while this market rally has room to run, investors should be mindful of potential reinflation risks shutting this Wall Street party down.
Now, bullishly, there were no upside surprises in this most recent report. In fact, across the board, October inflation metrics came in-line with expectations.
Year-over-year, CPI rose 2.6%, while core inflation climbed 3.3%. And month-over-month, CPI rose 0.2%, while core inflation increased 0.3%.
All came in as expected. And at a time when reinflation worries have been running high, an entirely “as expected” CPI report is a good thing.
Plus, the underlying trends in the report are quite encouraging. Excluding housing, inflation in most major categories is either falling or trending below its long-term average inflation rate.
For example, the food inflation rate fell from 2.3% to 2.1% in October – below its long-term average of 2.2%. The energy inflation rate was -4.9% in October – way below its long-term average of 3.4%. Across all other commodities, inflation clocked in at -1.0% last month – also way below its long-term average of 0.2%. And medical care services inflation is now running right around its long-term average level.
The only holdup? Shelter.
Shelter Inflation Remains Stubbornly High
At 4.9%, shelter inflation is running way above its long-term average. In fact, after declining for several consecutive months, it actually rose in October.
But it has also become abundantly clear that the Federal Reserve won’t kill shelter inflation unless it opts to tip the U.S. economy into a recession. That is, throughout 2022 and ‘23, the Fed jacked up interest rates in one of its fastest and most aggressive rate-hiking cycles ever, leading to a surge in mortgage rates. Those higher rates barely put a dent in shelter inflation, implying that it is largely out of the Fed’s control.
This is a supply problem.
Now, excluding shelter, inflation is at 1.3% right now – a very normal level.
As such, excluding housing, it seems inflation has returned to normal. And that should encourage the Fed to continue cutting interest rates for the foreseeable future, thereby adding additional support for the U.S. economy.
Indeed, before October’s CPI data was released, the odds of a December rate cut were at just 60%. That has since jumped to over 80%. The market is still pricing in three more rate cuts for this cycle.
That is the good news about today’s CPI report. It broadly confirms that the economic backdrop is presently supportive of continued stock market strength.
But it may not remain that way forever.
Be Mindful of Reinflation Risks
Of the six biggest categories in the CPI report – Food, Energy, All Other Commodities, Shelter, Transportation Services, and Medical Care Services – four are currently running at or below long-term “normal” levels. But only two of those six are seeing falling inflation rates.
Inflation is flat across All Other Commodities, and rising for Energy, Shelter, and Medical Care Services.
On a headline basis, the overall U.S. inflation rate did rise from 2.4% to 2.6% in October. And current estimates from the Cleveland Fed suggest it will rise again to 2.7% in November.
In other words, the stock market has benefitted from a falling inflation rate over the last two years. But that is no longer the case.
The Final Word
Inflation is no longer falling. It is, at best, flatlining – and one could even say that it is rising now.
All of this, of course, is happening before potential policy changes in 2025 and 2026, including tax cuts, deregulation, tariffs, and possible mass deportations – the sum of which could create upside inflation risks.
Indeed, during Donald Trump’s first term as president, inflation rose from 1.6% in mid-2017 to nearly 3% by the end of 2018.
So – what does all of that mean?
Inflation isn’t a problem right now; though it could become a problem again in the next few quarters.
Be mindful of those risks. But don’t let them scare you out of the markets.
This is clearly a stock market that wants to go higher. Let it. Better yet, ride it higher. But don’t get caught up in the euphoria or blinded by greed.
These reinflation risks are very real. They won’t derail the market today, tomorrow, or next month. But they could at some point relatively soon.
So, remain vigilant, and create an investment game plan for such headwinds.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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