From Surge to Stability

“This is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”

- Winston Churchill

At the most recent Federal Open Market Committee (FOMC) meeting, the committee decided to hold its policy rate unchanged but indicated that change was likely coming. During the press conference following the meeting, Federal Reserve Chair Jerome H. Powell signaled that by the next FOMC meeting in September, a rate cut would be “on the table” as long as inflation data continues to cool.

Looking at market expectations via an inflation derivatives market known as “CPI fixings,” the next headline year-over-year (YoY) Consumer Price Index (CPI) reading, to be released on Wednesday, Aug. 14, is expected to be 2.9% for July. This would be the lowest YoY inflation figure since March 2021.

This week’s chart shows the number of consecutive months when the headline CPI YoY inflation rate has been 3.0% (rounded to the nearest 0.1%) or higher. If the aforementioned market expectations turn out to be correct, the current streak of 3% or higher for U.S. inflation rate will have ended with June 2024, which would amount to a consecutive streak of 39 months. As the chart shows, the current streak is the fourth longest in the U.S. since World War II. The U.S. hasn’t seen a series of high inflation prints like this since the early 1990s. Amazingly, since the streak started in April 2021, the CPI is up 18.2%.

In a more benign inflation regime, such as the one we experienced between October 1991 to March 2021, the average inflation rate was 2.2%, and bonds performed well as interest rates generally declined. This time might very well be no exception. If U.S. inflation continues to cool as expected in the coming months, this should give the Fed continued confidence to initiate its well-anticipated policy-rate cutting cycle. History suggests that the U.S. Treasury yield curve tends to steepen as front-end yields decline more than long-end yields, and Treasuries tend to perform well overall during policy-rate cutting cycles.

As we highlighted in our recent articles, titled “Game Changer” and “Super(core) Cool”, U.S. inflation data has slowed sharply in the second quarter. Even if the July CPI comes in hotter than expected, the overall inflation rate in the US should fall below 3% soon. If and when this occurs, many in the financial industry, as well as the broader media, may take notice of the end of the high inflation regime and the beginning of a period of inflation considered by many to be “normal”. We shall see if this truly represents a return to normalcy or a temporary decline.