Liz Looks at: Falling Inflation

By: Liz Young · November 16, 2023 · Reading Time: 4 minutes

Cool and the Gang

This week has already had a packed lineup of economic data, most importantly the CPI release that came in below consensus estimates, and pushed the rally pedal to the metal. Cooling CPI data is a welcome sign in an environment where inflation has been public enemy #1 for the better part of two years.

As a result, Treasury yields fell dramatically across the curve on Tuesday, with the biggest moves occuring in maturities between 2 and 10 years. In fact, the 2-year Treasury yield – which is thought to represent the market’s expectation of Fed moves – saw an intraday drop of 24 basis points, putting it in the 98th percentile of intraday moves since October 1998. Rare, to say the least.

For the first time this cycle, the fed funds futures market completely removed the expectation of additional hikes, and pulled the timing of the first expected cut forward one month to May 2024. For reference, less than a month ago the first cut was expected to be in July 2024.

So far, the market is seeing the latest inflation data as a victory, the fall in yields as a reason to buy stocks, and the whole kit and caboodle as an indication that the Fed is done hiking rates, and the future is bright.

Celebrate Good Times

There are certainly things to celebrate: the drop in yields, the cooler inflation print, the stock market rally, the seasonal tailwinds that November and December tend to bring, and the likely end of the hiking cycle.

We can also celebrate that as it stands today, unemployment is still low, and the economy is adding jobs at a healthy rate.

It’s no secret that I’ve been on the more cautious side of fence all year due to a variety of factors, including but not limited to: my belief that we are very late in the business cycle, yield curve inversions at several different maturities, the fast and furious rise in the fed funds rate, the regional banking crisis that is still not solved, narrow stock market leadership, increasing delinquency rates in some consumer borrowing categories, slowing activity metrics, government deficits, and increased volatility in global rate and currency markets.

A question I’m frequently asked is what would change my mind, and cause me to turn more optimistic. My answer is some version of: inflation getting closer to target across the board (meaning most or all of the inflation readings getting closer to target, not just one particular measure), a Fed that is satisfied with inflation, no concerning increase in unemployment or layoff announcements, an upward sloping yield curve, an end to the Bank Term Funding Program, and activity metrics such as PMIs that return to signaling expansion.

Admittedly, that’s a lot of boxes to tick, hence my continued cautionary tone. But I view that list as equal to, if not shorter than, the list of things that still signal caution. Perhaps the most important of which is actually still missing, and that is patience and timing. “Later than expected” doesn’t equal “never going to happen.”

There’s a Party Going on Right Here

No matter which side you’re on, the reality is that what’s happening is positive. I’m not one to stand in the way of a party, so by all means, party on. The great thing about this particular party is that even if you’re on the cautious side, chances are you have a position in bonds and/or gold — both of which have also done well recently.

It actually feels like we’re in a time when everybody’s winning. The question is, how long will it last? A social rule of thumb I’ve long followed is, “leave the party while you’re still having fun.” Being a disciplined investor is knowing that markets don’t hold the same tone forever, the only thing that’s for sure is it will shift at some point. No matter where you’re sitting at the party, don’t overstay your welcome.


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