Inflation mildly better, markets roar

Damien Klassen

Nucleus Wealth

US inflation came in lower than expected overnight. Markets roared higher.

It was a little better than last month. It was better than expectations. It wasn’t a fantastic result, but it seems markets didn’t need that. See the tables below:

Given some technicalities in calculating rent inflation, services inflation is unlikely to decline quickly.

How should we look at inflation reversion?

There are two ways to consider reversion:

1. While central banks will force inflation back to 2%, prices will remain structurally higher.

2. Prices have been temporarily shocked, but will return to the prior trend

Goods are probably more likely to be in the second category, services more likely to be in the first. Given the Ukraine war, gas prices are likely to be in the first category. Oil is more transportable, and so probably has a chance for either.

The shape of future inflation or deflation depends on how many things you think will fit into each profile.

Going forward

The way the maths are at the moment, annual inflation is going to remain high for some time. If inflation went immediately to a 2%p.a. rate, by March next year both core and headline inflation would still be above 4.5%:

Say you were expecting imminent deflation in many categories. If the US started printing -0.7% per month inflation every month from November, annualised inflation would still be above 2% until March 2023.

It was a fascinating reaction by markets, celebrating a mildly better, but still bad inflation report with a 5% rally. My expectation is still that central banks want to jump up and down a few times on the corpse of inflation to make sure that it is truly dead before reversing course. With that in mind, I’m expecting very low inflation or deflation by mid-2023. But, even with that expectation, the headline annual inflation figure will stay high for at least six months.

Will markets celebrate inflation falling over the next few months the same way? If so buy equities now. Or is this a buy the rumour of lower inflation, sell the fact as earnings get hit by weaker demand? If so sell into the rally.

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The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Nucleus Advice Pty Ltd - AFSL 515796.

Damien Klassen
Head of Investment
Nucleus Wealth

Damien runs asset allocation and global stock portfolios for Nucleus Super, Nucleus Ethical and Nucleus Wealth. His 25 year+ career includes Global Quant at Schroders, Strategy at Wilson HTM & co-founder of Aegis.

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