AFMC - CPI Report Is A Red Carpet To A Bull Market

2023-05-10 09:53:46 ET

Summary

• The disinflationary trend continues with a broad decline in the rate of increase for the CPI components.
• We're on track for the Fed's 2% target with a big decline in shelter and transportation costs.
• This report should end the Fed's rate hike cycle, and a bull market should follow.

The inflation hawks love to pounce on monthly data that doesn't fall exactly in line with the long-term trend, as though it's bringing the trend to an end or stalling out any further progress. Yet nothing moves in a straight line. They will have difficulty finding fault with this morning's Consumer Price Index, which saw a modest downtick in the annual rate from 5% in March to 4.9% in April. The monthly increase of 0.4% was in line with expectations, as was the core rate at 0.4%. The annual rate for the core fell from 5.6% to 5.5%. This results in 10 consecutive months of progress during which the overall rate has fallen from its peak of 9.1%. That said, it appears to be a "gotcha" moment for overzealous bears who are hunting for any number that might breathe life into a narrative that's losing its validity by the day. They say the rate of improvement is stalling out.

During this inflationary period, concerns have shifted from energy to food to goods to housing to what is now the primary focus-non-housing core services. The inflation hawks are running out of index components to complain about. As for the services inflation that remains "sticky," it's primarily due to shelter and transportation costs, as can be seen in the chart below. Yet take a look at the rate of increase for the March components of the CPI, as seen below, and compare them to April.

Nearly every single component is realizing a lower rate of increase in April.

The shelter index is the most dominant factor in the core rate of inflation, accounting for more than half of the overall increase in the index. The good news on this front is that disinflation can clearly be seen in the pipeline with the decline in home price and rental rate appreciation feeding into the 12-month average each month. With more than one million apartments under construction in the US, which is the largest number since 1974, vacancy rates are rising and should return to pre-pandemic levels. That also should alleviate the upward pressure on rents and lower shelter inflation to 2% or less later this year. This is why inflation hawks have zeroed in on non-housing services.

Medical care price increases have plunged to less than 1%, while transportation services inflation remains elevated and accounts for approximately 25% of non-housing services component, led by airfares. Last month's 11% increase, which is down from 13.9%, accounted for more than 60% of the overall increase in core services. When will this abate?

I attribute the demand for transportation services to the consumer focus on "experiences" over goods purchases. In my view, this has been fueled by the tremendous build-up in excess savings that followed the pandemic. This mountain of excess savings is expected to return to pre-pandemic levels during the second half of this year, and the demand for transportations services should follow.

While shelter and transportation costs are putting upward pressure on the core Consumer Price Index today, they may be weighing on it as soon as the third quarter of this year. This will be a bullish development provided the labor market remains healthy and wage gains continue to run in excess of price increases, as they started to do last month. Real wage growth should sustain real consumer spending growth, which is the lifeblood for a continuing economic expansion.

Fed officials may already recognize these developments, but neither Chairman Powell or any of his foot soldiers will speak openly about it for fear of igniting a rally in risk assets that could undermine inflation expectations. This is an extremely bullish CPI report and it paves the way to a bull market for the S&P 500.

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