Immaculate Disinflation or Premature Jubilation?

Inflation TLDR

Cooling inflation in the UK and US, better China data…all rather risk on. Dollar down hard yesterday, stocks up bigly, yields pressured and everyone seems to be buying the idea that the Fed pivots early next year – fully priced for a cut by May and roughly 30% odds for one as early as March! This is a sharp repricing in fed funds futures on it seems some nascent cracks in the labour market after the NFP and slightly cooler-than-expected inflation…seems overdone. Oil down a bit after striking a week high yesterday on some optimistic demand indicators from OPEC and the EIEA, gold up for a third day to couple of fib levels at $1,968 area.

Victory?

A sharp fall in inflation has prime minister Rishi Sunak crowing – he's met his pledge to halve inflation this year. Blame external forces for the inflation and then take credit for bringing it down: it’s the classic politicians’ playbook of economic smoke and mirrors. Will it help the Tories? Maybe a bit – wages are outpacing inflation, and it helps the BoE deliver rate cuts next year, just in time for the election in the autumn. And in a nice parallel for Sunak it’s the steepest decline since ‘92 ...do we see Starmer as the hapless Kinnock, Sunak as the embattled Major who’s inherited a sclerotic, scandal-riven 13-year-old Tory government...? UK inflation more than anticipated with CPI at 4.6% against 6.7% prior and forecast 4.8%. The core CPI declined to 5.7% from 6.1%, driven by the lowest inflation rate for housing and household services since records began.

Or Premature Celebration?

The IMF;

“Most unresolved episodes involved “premature celebrations”, where inflation declined initially, only to plateau at an elevated level or re-accelerate. Countries that resolved inflation had tighter monetary policy that was maintained more consistently over time, lower nominal wage growth, and less currency depreciation, compared to unresolved cases. Successful disinflations were associated with short-term output losses, but not with larger output, employment, or real wage losses over a 5-year horizon, potentially indicating the value of policy credibility and macroeconomic stability.”

But the inflation data this week does one thing for sure – the bar for further hikes is getting higher – so the question remains as it has for some weeks now – rather than how high, how long? Again, the question is: can they now declare victory over inflation? Has the paradigm not changed – was it in fact ‘transitory’? I suppose everything is transitory on a long enough timeline, and it’s taken the most aggressive hiking cycle in 40 years to get to this stage.

How does this narrative change? All of a sudden: upside shock to inflation – this seems a possibility – the Fed has cautioned about head fakes. Slowly: inflation stays persistently around 4% but no big shocks. The market is going to struggle to take more hawkishness from the Fed unless the CPI really stalls at this still-too-high level for at least the next couple of months. The Fed will hope this is the immaculate disinflation but I think this is a bit premature.

Couple of Interesting Elements

Bank Rate now above CPI for the first time in years and the drop in the headline rate is down to a huge decline in housing costs...what happens when rate cuts happen? And we should note that the bulk of the drop came from energy due to a reduction in wholesale prices and the Ofgem cap. Here’s the ONS;

“Housing and household services prices fell by 0.3% between September and October 2023, compared with a rise of 3.4% between the same two months a year ago. This resulted in an easing in the annual rate to 1.9% in October 2023, down from 5.7% in September and a peak of 11.8% in January and February. The decrease in the rate between September and October 2023 reflected downward effects from gas and electricity. Gas costs fell by 31.0% in the year to October 2023, compared with a rise of 1.7% in September. This is the lowest annual rate since records began in January 1989. Electricity costs fell by 15.6% in the year to October 2023, compared with a rise of 6.7% in September. This is the lowest annual rate since records began in January 1989”.

This morning European stock markets are continuing the risk-on momentum with the FTSE 100 rallying 1% to lead the charge. The FTSE 250 also notched a gain of almost 2% after a stonking 3.5% pop yesterday.

Elsewhere

China data for October beat expectations – industrial production grew 4.6% yoy vs f/c 4.4% while retail sales rose 7.6% yoy vs f/c 7.0%. Japan Q3 GDP shrank by an annualised 2.1%, which was more than expected. GBPUSD – after a big rally yesterday with the dollar offered across the board on lower Treasury yields we are seeing some giveback today after the inflation numbers.

SPX – looking at the late summer swing high just above 4,500