Lately, it’s been easy to see the optimism. As of the Friday close, the S&P 500 is up 15% so far this year (not including dividends) and up 23% (again, without dividends) versus the lowest bear-market close back in October.
Some investors attribute this to the Federal Reserve being very close to finishing with the series of rate hikes that started back in March 2022. But that doesn’t really make sense. If investors thought the Fed was finished (or nearly finished) because it had tightened monetary policy enough to induce a recession sometime soon then we don’t think stocks would be going up as they have of late.
Instead, what makes more sense is that stock market investors think the Fed is nearly done and will not induce a recession, that it has somehow positioned monetary policy to be tight enough to bring inflation back down to its 2.0% target but not so tight that we have a recession.
We hope they’re right about this; wouldn’t it be great! Unfortunately, we still have strong doubts and think the US is headed for a recession. If monetary policy is tight enough to fix inflation, it’s going to hurt economic output, as well.
Yes, CPI inflation has slowed down substantially in the past year. The consumer price index is up 4.0% versus May 2022 while it was up 8.6% in the previous year. But this slowdown is largely due to volatile categories like food and energy. “Core” CPI inflation, which excludes food and energy, has barely slowed, to 5.3% from 6.0% a year ago. So-called “Super Core” CPI inflation – which excludes food, energy, other goods, and rents – has slowed to 4.6% from 5.2%.
Other measures of CPI inflation calculated by the Cleveland and Atlanta Federal Reserve Banks, which are designed to measure the underlying pace of inflation, also suggest no major decline. In other words, we think recent optimism about inflation is overdone.