Ingrams June 2023

SMALL BUSINESS ADVISER FINANCIAL ADVISER

by Scott Colbert

Inflationary Cycle Suggests Things Cooling Off

Signs are the Fed may be winding down its push for higher rates—but it’s not certain yet. Through mid-June, stock markets have held up remarkably well for 2023. The S&P 500 is up almost 14 percent now on a year-to date basis. Large-cap international stocks are in second place, up almost 11 percent now on a year-to-date basis. Even smaller stocks have started to participate with this big stock rally. The Russell 2000 is now up over 7 percent. Bonds and cash, of course, are up on a year-to-date basis as well. A typical balanced portfolio is likely up at least 6 percent or perhaps as much as 8 per cent, or even more, if you’ve had a concentration in those large-cap growth stocks. Of course, this is a much better return so far on a year-to-date basis than the average balanced portfolio, which was down closer to something like 11, 12 or 13 percent last year. On a year-over-year basis, remarkably, the trailing 12-month CPI has fallen from 4.9 per cent to just 4 percent. That’s a remarkable drop because we lost last May’s CPI print where in flation was an entire 1 percent just alone that month. That’s the good news. If we look under the hood of the CPI, we’ll note that it’s been fall ing now consistently for the past 11 months, a remarkable drop from its high last June, coming in at 9.1 percent. Not All Good News Where’s the bad news? We know that the CPI has both food and energy in it. The Federal Reserve likes to take food and energy out and look at what they call core inflation. Food and energy are ba sically 20 percent of the CPI. Food is 13 percent and energy is 7 percent. When we look on just a core basis, CPI was up 4/10 of a percent. On a year-over-year basis, the core CPI is still a relatively sticky 5.3 percent, down from its high last September of 6.9 percent, but nonetheless much more sticky than the headline CPI number. There’s even good forward news when it comes to looking at the core CPI. When we look at just the core CPI, shelter makes up a rather remarkable 43 percent of it. What is it that drives the shelter part of the CPI? Well, it’s primarily what it costs to live in a single-family home. In addition, part of it has to do with rents on a year-over-year basis and the last two small components are what it costs to insure your apartment or your house, or what it costs you when you stay away from home, lodging, essentially at a Holiday Inn or a Marriott. Housing as a percent, 43 percent of the core CPI, has been coming in at an 8 percent year-over-year pace. It’s the biggest driver of this sticky core inflation. Here’s the good news on hous ing: Home prices have been falling now on a year-over-year basis for almost a year. Rents have been declining, not negative on a It’s really been a remarkable bounce back so far, particularly when viewed in the context that the Federal Reserve has been raising rates for the past 15 months. The monthly Consum er Price Index for the month of May, the sum total of all goods and services, was only up 0.1 percent.

year-over-year basis, but they’ve been in creasing at a much slower pace. It takes a while for the way the Federal Reserve looks at housing to work its way into the CPI numbers, often with as much as a 12- to 18-month lag. In other words, it lagged on the way up when home prices were soaring, it wasn’t contributing a lot of inflation. Now that home prices are declining, it hasn’t started to pull the core inflationary num bers down. We would expect that core in flation for housing will begin to decline from 8 percent to something closer to 4 percent as the year progresses. If we can get there,

that would be enough to take the core CPI from its sticky 5.3 per cent handle to a 3.5 percent rate on a year over-year basis. Bottom line is this, these infla tionary statistics are probably viewed as very good to the Federal Re serve. Does it take the pos- sibility of future rate

As home prices retreat from a huge spike, we’ll likely see improvement in the nation’s core inflation numbers.

hikes off the table? Yes, to the extent that core inflation continues to make some progress, and that headline inflation makes progress. I think the home prices are going to start to help bring those core in flationary rates down. It might give the Fed enough room to sit tight for the rest of the year, but still I think we’re going to have a rather hawk ish pause from the Fed, because there’s a brief minority that suggest while the in flationary trends have been in the right direction, they want to make sure that they continue and move onward towards that 2 percent rate. That’s still much low er than this relatively sticky 3 percent to 5 percent rate that we have today. Will they be perpetually on pause? I doubt it. I still think there’s probably like ly a rate hike coming in July, but we’re very close to the end of this cycle and it’ll just simply depend upon how quickly the economy’s cooling, how much impact this has had ultimately on employment. Then, eventually, will we or won’t we push our way towards a recession?

Scott Colbert is executive vice president and chief economist for

Commerce Bank. P | 314.746.8557 E | scott.colbert@

commercebank.com

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June 2023

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