This economist says “the de-inflation wave is piling up” even as investors anticipate a significant increase in the Fed’s interest rate

Signs of easing inflation are emerging even as investors fear that Federal Reserve Chair Powell and his colleagues will continue to fight inflation with aggressive interest rate increases that have hurt both stocks and bonds, according to a Capital Economics note.

While it looks like the Federal Reserve may announce on Wednesday that it is raising its benchmark rate by three-quarters of a percentage point for the third time in a row, Paul Ashworth, chief North American economist at Capital Economics, expects it to soon follow with a less aggressive stance on monetary policy.

“If we are correct that inflation will ease soon, officials will quickly turn to much lower highs,” he said in a note on Tuesday. Referring to the Consumer Price Index, he said, “Continuing low gasoline prices and declining food inflation will affect the core CPI over the next month or two.” He also cited indications of declining inflation in core CPI data, which excludes energy and food.

“Despite a larger-than-expected 0.6% rise in core prices in August, there are increasing signs of inflation abating there as well,” he wrote. Supply shortages are back to normal, with the company’s product shortage index now indicating that “commodity inflation could ease to 2% before the end of the year, from 7% in August,” according to Ashworth.

Capital Economics note dated September. 20, 2022

The Federal Reserve aims to bring inflation down to its 2% target range through the monetary tightening that began earlier this year, crushing stocks and bonds.

The US stock market closed lower on Tuesday, as investors await clues on the future path of the Federal Reserve to raise interest rates after it concludes its two-day monetary policy meeting on Wednesday.

Dow Jones Industrial Average DJIA,
-1.01%
It is down 1% on Tuesday, while the S&P 500 SPX is down,
-1.13%
down 1.1% and the Nasdaq Composite,
-0.95%
It’s down about 1%, according to FactSet data.

The federal funds rate is in the range of 2.25% to 2.5% before the expected rate increase from the central bank on Wednesday. Federal Reserve fund futures suggest the price could peak at nearly 4.5%, according to a Capital Economics note.

“These expectations are higher than ours, mainly because we expect inflation to come down more clearly,” Ashworth said. The inflation of basic services is fueled by the rapid increase in rents, he said, “but the latest private sector measures indicate that inflation for new leases is slowing significantly.”

In his view, an “opposite wave of inflation is forming”.

“There are broader signs of deflation in services from lower airfares to hotel rates, while lower long-term inflation expectations have markedly reduced the risks of a price and wage spiral,” he said. “The upshot is that we expect to see clearer and more convincing signs of de-inflation in the CPI numbers soon.”

Meanwhile, higher real yields weigh on stock prices and push corporate bond spreads higher, his observation shows.

For example, the US ICE BofA’s high-yield index option-adjusted spread was 4.88 percentage points compared to similar tanks on Monday, up from 4.2 percentage points on August 11, according to data on the Federal Reserve’s website in St. Louis.

iShares Boxx ETF HYG Stock,
-1.02%
It fell about 1% on Tuesday, FactSet data shows. The fund has lost 11.6% this year on a total return basis through Monday.

We see: Why soaring Treasury yields plague the stock market before the next Fed rate hike

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