Good evening,

 

The Fed has a needle to thread: too little and inflation persists, too much and the economy enters a recession.

 

The U.S. Consumer Price Index (CPI) for August was released over the past week and it was up 8.3% year over year, higher than expected. Food and energy price pressures remained elevated.  The core measure, which excludes food and energy was higher than expected and above the July reading.

 

Nevertheless, my view on inflation remains unchanged.  It should recede in the months to come. You don’t have to look too far to understand why. Shelter is the largest component of inflation, accounting for nearly a third of U.S. CPI. It is made up of lodging away from home, rent, and housing-related costs. The latter two have shown no signs of slowing yet, and in fact increased in August. But, these two categories have historically followed home prices with a meaningful lag. We know home prices are under pressure as a result of substantially higher mortgage costs. As a result, it is just a matter of time, before trends in the largest component within the CPI basket begin to subside.

 

Inflation may also be at risk of falling victim to recessionary-like forces that appear to be on the rise. In recent days, a few industrial conglomerates ranging from aluminum and steel makers to shipping and parcel delivery companies have warned of deteriorating conditions which have led them to issue profit warnings. Part of this appears to be cost-driven and a meaningful shift in demand away from goods towards services.

 

A deteriorating economy is by no means something to look forward to. But, it may be a necessary ingredient to reduce inflation. In the interim, I expect equities to remain vulnerable as markets digest the risks to corporate earnings.

 

Enjoy your weekend.

 

Tim