News Highlight: Latest US Inflation

“Apprehensive” was the word that seemed to dominate the financial markets on Wednesday this week, ahead of the latest US Consumer Index (CPI) report, telling us the degree of inflation consumers faced in July. Most market commentators had already pencilled-in a slight drop in the inflation rate. That assessment was correct – the CPI fell in July to 8.5% compared to June’s annualized rate of 9.1%.

The dilemma for the US Federal Reserve has intensified – when it next meets should it continue to put interest rates higher? As we have said before, the risk of doing nothing is that inflation – which has its own particular dynamic – might stick around at this level, and make all US consumers poorer. But putting up interest rates aggressively could push the US into recession.

The US economy is still running red-hot – its unemployment fell to 3.5% in July, a half-century low, and back to what it was in February 2020. Job vacancies in the US dropped by 605,000 to 10.7 million by the end of June; still, there are almost two job vacancies for every available worker. Employers added 528,000 jobs that month, markedly higher than June’s 398,000.

News of the massive job hires had an immediate effect on US Treasuries – the yield on two year-Treasuries exceeded that of the 10-year; this inversion of the yield curve is widely regarded as heralding an economic contraction. And while jobs have been added, big employers (such as Ford and Walmart) have announced layoff plans.

The economist Nouriel Roubini sharply divides opinion but he warned of the Great Financial Crash two years before it happened. His view about where we are now is perhaps worth listening to. He wrote this week that the “Great Moderation” (characterized by low inflation, relatively stable economic growth and “sharply rising values of risky assets such as US and global equities”) is now over and will be followed by the “Great Stagflation” in which “long-term bonds and US and global equities will suffer, potentially incurring massive losses”.

The Biden Administration managed to squeeze the Inflation Reduction Act through the Senate last Sunday, which promises (if passed) to raise $739 billion and authorize $370 billion in spending on energy and climate change, reduce the deficit by $300 billion, will provide three years of subsidies in the Affordable Care Act, lower prices for prescription drugs, and introduce some fresh tax rises. The Act is oddly named; according to various sources it will have almost no impact on current inflation.

The major reason for the inflation drop seems to be a weakening of the price of gasoline, which rose to a national average of $5/gallon in mid-June and now average slightly more than $4/gallon. Gasoline accounts for just 4% of the overall CPI. The cost of food (almost 14% of the CPI ‘basket’) went up by almost 11%, the most since 1979 and shelter costs (almost 33% of the CPI ‘basket’) were 5.7% higher, the biggest rise since 1991.

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