The financial markets’ reaction to the US consumer inflation news of September 13 provides an extreme example of how surprising news plays in the day-to-day movements of share prices, interest and exchange rates.
The key global equity benchmark, the S&P 500, lost almost 5% of its opening value after the announcement that inflation was slightly higher than expected in August. This implies that the US Federal Reserve, which sets short-term interest rates, will be more aggressive in its anti-inflationary resolve, making a recession inevitable and more severe.
According to the recent trend in GDP, the US economy is already in recession, despite a fully employed labour force. Recession without rising unemployment would have been unimaginable before the Covid-19 lockdowns. The Fed failed to imagine the inflation that would follow the stimulus it and the US treasury had provided to the post Covid-19 economy. This has become a problem for investors and speculators, who are required to anticipate what the Fed will be doing to protect the value of the assets entrusted to them.
But it should be recognised that the US consumer price index (CPI) is in fact no longer rising — average prices fell marginally in August, as they did the month before. Perhaps not as much as had been expected. The headline inflation rate — the rate most noticed by households and politicians — reached a peak of 9.1% in June and has since fallen to 8.3% as the CPI moved sideways. The increase in prices over the past three months was lower — 5.3% per annum.
Yet even if the average prices faced by consumers stabilise at current levels until June 2023, the headline rate of inflation would remain elevated at 6% by year-end. One wonders just how realistic the Fed’s plans are to reduce inflation rates in short order. Patience is called for.
The true surprise in the inflation print was the trend in prices that exclude volatile food and energy prices. It was these supply-side shocks to prices that helped drive the index higher, and they are reversing sharply. However, the inflation of prices, excluding food and energy, remains elevated. They are now 6% ahead of prices a year ago. The Fed is known to focus on core rather than headline inflation.
The largest weight in the US CPI is given to the cost of shelter. This accounts for over 32% of the index, of which 28% is attributed to the implied rentals owner-occupiers pay to themselves. The equivalent weight in the SA CPI is far lower, at 13%. Where house prices go, so do rents, and the implicit costs — rather the rewards — of home ownership and inflation.
But surely the reactions of those who own more valuable homes are different to those who rent? Higher explicit rentals drain household budgets and lead to less spent on other goods and services. They are resented accordingly, as are all price increases.
Higher implicit owner-occupied rentals do the opposite. They are welcomed and lead to more spending and borrowing. House price inflation in the US had been rapid until recently, and rents may be catching up, meaning higher inflation rates.
Prices always reflect a mix of demand and supply side forces. But ever higher prices — inflation — cannot perpetuate themselves unless accompanied by continuous increases in demand. It is the effect of higher prices on the willingness and ability of households to spend more that is already weighing on the US economy.
Incomes are barely keeping up with inflation, and the supply of money (bank deposits) and bank lending in the US has stopped growing, further constraining spending. If inflation is caused by too much money chasing too few goods, the US is already well on the way to permanently lower inflation.
The danger is that the Fed does not recognise this in good time — as the marketplace fears.
• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.