Stocks reacted negatively to the latest inflation reading from the Consumer Price Index (CPI), which suggests that the Federal Reserve (Fed) will remain on its aggressive path of interest rate hikes for the foreseeable future.

This latest stronger-than-expected CPI report now has the market pricing in either a 0.75% or 1.00% increase in short-term interest rates rather than a 0.50% or 0.75% increase when the Fed updates its policy this Wednesday.

While the current economic data remains consistent with further economic growth, stubbornly high inflation and a more aggressive response from the Fed increases the chances of recession. This has us remaining neutral toward stocks and favoring the defensive Health Care and Utilities sectors and the cyclical Energy sector, where we continue to see tight supply due to a lack of investment.

Inflation Continues to Run Hot

The Consumer Price Index (CPI) ticked up 0.1% in August, contrary to the consensus of -0.1%. While energy prices declined 5.0%, down for the second consecutive month, that was insufficient to offset the increases in most other categories. Core CPI, which excludes energy and food, increased 0.6%, twice the gain in the previous month, and above the 12-month average of 0.5%. The consensus was for a steady 0.3% gain in the core.

On a y/y basis, the CPI eased only slightly to 8.3% from 8.5% in the month before, missing the consensus of 8.0%. Notably, food prices surged 11.4% from a year ago, the steepest rise since May 1979. Core CPI climbed 6.3% y/y, with core price pressures widespread. The median and trimmed-mean CPI measures, which exclude outliers, both reached new series highs since data began in 1984.

These broad-based inflation pressures reflect continued demand/supply imbalances primarily related to the pandemic and aggravated by the Ukraine war. Consumer demand remains strong, supported by low unemployment, excess savings accumulated during the pandemic, and the ongoing post-pandemic shift back toward more services consumption versus goods. While supply chains are slowly normalizing, lingering issues including labor shortages continue to put upward pressure on prices.

Other Economic Indicators Consistent with Slower Growth

Retail sales rebounded 0.3% in August, led by vehicle sales which jumped 2.8%. Retail sales ex-vehicles fell 0.3%, with the biggest driver a 4.2% drop in gas station sales, the most since April 2020, as prices at the pump continued to fall. As a benefit from lower gasoline prices, consumers spent more on other purchases. Retail sales ex-vehicles and gasoline were up 0.3%.

On a y/y trend basis, retail sales increased 9.3%, slightly up from the 9.2% pace in the previous month. Similarly, discretionary and core discretionary retail sales growth held up above mid-single digits. These rates of increase, however, largely reflect high inflation.

Industrial production fell 0.2% in August, its first decline in three months, with the decline concentrated in utilities (led by electricity output), with manufacturing output up 0.1% and mining flat. On a y/y basis, industrial production increased 3.7%. While momentum has peaked, it is not yet consistent with recession.

We continue to watch jobless claims as a timely and accurate economic indicator, and it remains consistent with a healthy labor market and further economic growth. Initial claims for unemployment insurance fell 5,000 last week to 213,000, its fifth consecutive decline and the lowest level since May. Continuing jobless claims ticked up only 2,000 last week to 1.403 million, still near its lowest level since 1970. The insured jobless rate was unchanged at 1.0%, barely off the record low of 0.9%. This suggests that labor demand remains strong, and the job market is tight.

In total, these indicators are consistent with slower, but still positive, economic growth with the Blue Chip consensus calling for about 1.0% economic growth in the third quarter.




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