Yields Plummeted on Benign Inflation Report

Posted by Jeffrey J. Roach, PhD, Chief Economist

Wednesday, November 15, 2023

Key Takeaways:

  • Investor risk appetite could increase in the near-term after the October inflation report, similar to the market reaction after the jobs report from a few weeks ago.
  • Headline consumer prices in October were unchanged month over month, pulling the annual rate of inflation down to 3.2% from 3.7% last month.
  • Core inflation rose 0.2% from a month ago as housing costs, insurance, and medical care increased in October.
  • Hotel prices fell in October, likely on the heels of declining demand for travel.
  • Air fares fell in October as fuel costs declined and competition among airlines put downward pressure on tickets.
  • Bottom Line: The annual rate of core inflation decelerated to 4%, the smallest rate since mid-2021 and should keep the Federal Reserve (Fed) from raising interest rates at next month’s meeting. Despite the deceleration, the Fed will likely continue to speak hawkishly and will keep warning investors not to be complacent about the Fed’s resolve to get inflation down to its long-run 2% target.

No Inflation in October

The October Consumer Price Index (CPI) showed inflation was unchanged from the previous month, indicating markets may finally get a reprieve from the nagging pressures of inflation. In October, CPI increased by 3.2% from a year ago, a decent deceleration from the 3.7% annual rate registered in September. Following the release, both equity and bond markets responded favorably as the official metrics showed some improvement with inflation.

Digging a Bit Deeper

Energy prices fell 2.5% and was the biggest contributor to the unchanged headline stat. Gas prices fell 5%, the biggest monthly decline since May. Falling energy prices will provide a bit of a reprieve for consumers, especially lower income families more sensitive to gas prices. Other categories are also showing some encouraging signs. Both new and used vehicle prices declined in October. Used vehicle prices have declined now for five consecutive months, although used vehicle prices are up over 30% since the onset of the pandemic.

Airfares also declined in October. In fact, the price index for airline tickets is below 2019 levels and could indicate a cooling off in demand for travel.

Too Early to Declare Victory

The Fed will by no means declare victory since the annual core inflation rate in October was 4.0%, double the long-run target rate set by the Fed. However, the trajectory is encouraging.

View enlarged chart

As shown in the chart above, the annual rate of headline inflation is 3.24% and will likely decline further from here. Despite inflation running above the Fed’s target, the Fed will likely hold rates steady at the next few meetings as policy makers—and investors too, for that matter—remain concerned about the lagged effects of monetary policy. Given the speed of the past rate hikes, many argue the economy and markets have not yet felt the full impact of the policy tightening.

From an investment standpoint, we saw an increase in risk appetite after this report and we could see some encouraging moves in the near-term. Overall, the Strategic and Tactical Asset Allocation Committee (STAAC) remains neutral on equities, maintains a positive bias towards growth stocks, and favors large caps over small caps. High valuations, tight financial conditions, and the potential for a recession (albeit mild) make the STAAC wary of taking on additional risk as investors prepare to enter the New Year. With the Fed likely done hiking rates and yields at attractive levels, bond returns have become increasingly competitive with equities.


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