- US inflation falls to 3.2 per cent in October
- Rates peak could mean soft landing is a reality
'Immaculate disinflation' almost sounds biblical, but slowing price rises and a calm jobs market point to a potential for a recession-free bounce back from this rate-hike environment in the US. The question now is over consumer spending, as major retailers reported sales drops in the third quarter.
In the year to October, the consumer price index (CPI) rose just 3.2 per cent which was below the 3.3 per cent expected, according to the US Bureau of Labor Statistics. On a monthly basis, inflation was 0.4 per cent. The core measure, which excludes food and energy, rose 4 per cent year-on-year which was also just below expectations of 4.1 per cent. The immaculate part of this disinflation period is that the jobs market remains fairly stable. Employment has remained steady in the US.
Falling inflation coupled with steady economic growth is the ideal scenario for asset prices. Last week, the S&P 500 index rose 2.4 per cent, having jumped on the day of the inflation report. Meanwhile, the US 10-year treasury yield is now down from its peak of 4.93 per cent at the start of the month to 4.53 per cent. Yields move inverse to the bond price.
At the start of the hiking cycle there was belief the Federal Reserve wouldn’t be able to bring inflation back down without causing a recession. However, this inflation report coupled with the fact the US economy grew almost 4.9 per cent year-on-year in the third quarter is altering this narrative. “In history it's rare that you get immaculate disinflation but there is an argument the labour market can ease, and vacancies can fall, without a big increase in unemployment,” T Rowe Price chief economist for US fixed income, Blerina Uruçi, told Investors’ Chronicle.
The question is whether the US will be able to avoid a recession in the coming year given there is some evidence in the last month that consumer spending is starting to slow, and according to Uruçi US consumers make up 70 per cent of GDP.
Early last week, retailer Target (US:TGT) announced in the three months to October its comparable sales dropped 4.9 per cent as consumers faced more economic headwinds. “Pressures like higher rates, the resumption of student loan repayments, increased credit card debt and reduced savings rates have left them with less discretionary income,” said Target chief executive Brian Cornell on the earnings call.
Then on Thursday, the US biggest retailer Walmart (US:WMT) announced that it expected to see some softness in the run up to Christmas. Despite year-on-year revenue rising 4.9 per cent, management warned there was evidence in October and November that consumers were becoming more cautious. “Sales have been somewhat even, and this gives us reason to think slightly more cautiously about the consumer versus 90 days ago,” said Walmart chief financial officer John Rainey on the earnings call.
There is a belief that with inflation falling the effective Fed fund rate has peaked at the target range of 5.25-5.5 per cent. Some economists now expect inflation to start falling and the Fed to begin cutting rates. ING chief international economist James Knightly expects the rate to fall to 4 per cent at the end of next year, while the market is expecting it to fall to 4.5 per cent. “With growth concerns likely to increase over the same period, this should give the Federal Reserve the flexibility to respond with interest rate cuts,” he said.
T Rowe Price’s Uruçi is also expecting rates to come down because of the dovish language of the Fed. However, she believes this will happen without the US having a recession. “There is a slight uptick in auto loan delinquencies, but the numbers currently don’t suggest we are going to fall into a recession,” she said.
Beyond next year is much harder to predict. The country could slip back into the low growth, interest rate and inflation world that characterised the years after the financial crisis. However, with the 10-year treasury yield above 4 per cent shows the market sees this as a wholly new economic regime. “The deflationary forces of globalisation have peaked and it seems like we are going to have to get used to higher interest rates more permanently,” said Uruçi.
