QQQ - November CPI: The War Against Inflation Is Over

2023-12-12 09:30:02 ET

Summary

• The inflation rate is falling, nearing pre-pandemic levels, with long-term interest rates falling and stocks rising.
• Consumer Price Index (CPI) rose 0.1% in November, with a year-over-year rate of 3.1%, driven by shelter costs.
• Rental supply is increasing, leading to declining rental prices and a potential decrease in shelter costs, bringing inflation closer to the Fed's target.

I have insisted for nearly 18 months that the rate of inflation would fall as fast as it rose, and except for this summer's speedbump in energy prices, it looks like that is what has happened. The pre-pandemic levels of inflation are within sight, and the consensus of investors recognizes that we are seeing long-term interest rates fall and stocks soar on strengthening breadth. The soft landing is upon us.

The Consumer Price Index ((CPI)) rose 0.1% in November, which was one tick above expectations, due to shelter costs, resulting in a year-over-year rate that declined from 3.2% to 3.1%. The temporary rebound in energy prices, which was fueled by a speculative late-summer surge in oil, has completely reversed, reaffirming the disinflationary trend.

The Federal Reserve is focused on the core rate, excluding food and energy, which rose 0.3% as expected, resulting in a year-over-year rate of 4.0%. That matches the prior month's two-year low. What stands between the current rate and the Fed's target of 2%?

As I noted last month, shelter costs continue to be the most influential factor in keeping the core rate of inflation elevated, as the core CPI less shelter costs are already running at the Fed's target of 2%. Therefore, when will the annualized increase in shelter costs abate?

Supply in the rental space is on track to surge , as 361,000 multifamily construction projects have been completed this year through October, which is more than any year since 1987. This is why the median national rent, as measured by Apartment List, was down 1.1% year over year in November. This is leading landlords to offer incentives in hopes of luring new renters, whereas a year ago there were bidding wars to obtain rentals. In 2024, analysts expect as many as 450,000 additional units to come to market. As the year-over-year declines in rental prices factor into the annualized number, shelter costs should plummet.

There is an extremely close correlation between rents and the shelter component of the CPI. Shelter accounts for 70% of the increase in the core rate over the past year. Current rental rates indicate that shelter costs, which rose 6.5%, should decline rapidly over the next six months. If shelter inflation falls to 3% on an annualized basis during the first half of next year, it would subtract approximately 1.7% from the current core rate of the CPI, bringing us within the crosshairs of the Fed's target of 2%. The market has been discounting this very high probability over the past several weeks.

Yesterday, the New York Fed's latest Survey of Consumer Expectations showed that one year ahead inflation expectations declined from 3.6% to 3.4%, which was the lowest reading since April 2021. This is another positive rate of change that should give Fed officials confidence expectations remain anchored. It is also notable that expectations for rent increases fell to the lowest level since January 2021.

Further evidence of expectations being anchored was revealed in the latest consumer sentiment survey from the University of Michigan, in which expectations for the year ahead plunged from 4.5% to 3.1%. That was the largest one-month drop since 2001, to a level very close to pre-pandemic levels.

Tomorrow, Chairman Powell will do his best to dissuade investors from being overly enthusiastic about lower short-term rates, but the inflation story indicates that an easing cycle should start very soon. The markets are once again discounting mechanisms after years of manipulation by the central bank. It has been a long time since they were allowed to operate freely, and it is a welcomed change.

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