Sticking the Landing

Following an impressive month, the S&P 500 sits on the verge of a new 52-week high. A softer mix of inflation and economic data over recent weeks has reduced the likelihood of further Fed Funds rate increases. In response, bond yields have moved sharply lower and the equity market has notably broadened. Thus far, the trade-off between lower inflation and higher unemployment has been minimal. The Fed appears to be sticking the soft landing, but it is still too early to suggest they are out of the woods entirely.

October’s inflation reports confirmed a lower trajectory of price increases. The headline consumer price index was flat month over month and up just 3.2% year over year. Lower food and energy costs were key. Core inflation, which strips out volatile food and energy prices, rose by 0.2% for the month and 4% for the year. Though slightly higher, it was the lowest rate in more than two years and was driven almost entirely by shelter costs. In addition, producer prices fell 0.5% in October. These wholesale prices often lead consumer prices and are an indication that inflation should remain tame in the months ahead.

For the Fed, the pressure to raise rates further has diminished. With the threat of more hikes largely off the table, investors have piled back into bonds and stocks. The stocks hit hardest by rates this year have begun to turn sharply higher. The most notable of this group is high dividend-yielding stocks. If rates fall, their mix of income and growth potential starts to look better than fixed income returns. Growth stocks have significantly outperformed value stocks this year, but that dynamic has shifted over the last month and a half. Next year’s trends often begin to take shape in the early months of the year. We are paying close attention.

Still, context is important. Monetary policy acts with a lag and despite moderating recently, consumers are still dealing with rates and prices far higher than at any point in the last decade. If policy stays restrictive, the pressure on consumers can continue to rise. In addition, government stimulus is responsible for much of the cushion consumers have built up. This has come at the expense of U.S. fiscal health and the bond vigilantes are never too far away. It is simply too early to say that the reprieve in rates is permanent or that more negative economic developments don’t lie ahead. For now, Fed officials seem to be getting it right, but cautious optimism is warranted as we move into 2024.

Thanks,
Preston May, CBE®
Research Analyst