But the June reports substantially weaken the argument that inflation is becoming embedded throughout the economy. And it reduces the immediate pressure on the Fed to raise interest rates.
Investors responded positively. The S&P 500 closed yesterday up approximately 0.4%, while the technology-heavy NASDAQ Composite gained 0.9%. Both indices were higher again today in mid-day trading.
Bond yields declined as well. One-Year Treasury yields are now approximately 0.15% lower relative to where they were prior to the reports, signaling significantly diminished expectations of a rate hike in the next year.
Long-term investors are justified in viewing these inflation reports with cautious optimism.
Many of the short-term inflation pressures associated with the recent energy shock have already made their way into consumer prices and are now beginning to ease.
Meanwhile, other inflation components that are generally unrelated to energy costs—particularly shelter—are showing clear signs of responding to several years of restrictive monetary policy.
Going forward, the economy also stands to benefit from the disinflationary impact of stronger productivity growth.
Warsh devoted a significant portion of his testimony yesterday to this possibility. He described AI as perhaps the most important economic transformation of his adult lifetime and said the United States is likely to be a major beneficiary.
He also made clear that the Fed should not respond to faster productivity-driven growth by automatically trying to restrain the economy, reiterating that the Fed under his leadership will not be “afraid of productivity-led growth.”
This is an important departure from the idea that strong economic growth must necessarily produce higher inflation.
If AI, automation, infrastructure investment, and other technological improvements allow the economy to produce more goods and services with the same amount of labor and capital, faster growth can coexist with more subdued price increases.
At the same time, Warsh remains firmly committed to the Fed’s 2% inflation goal and the objective of making the inflation surge of recent years “a thing of the past.”
Inflation trends tend to move in long waves. If we are indeed transitioning into a new environment of more subdued inflation, it could ultimately pave the way for substantially less restrictive monetary policy.
That would benefit most asset classes.
In addition to stocks and bonds, this includes “debasement trade” assets like gold and crypto. Both are highly sensitive to perceived changes in monetary policy and have moved higher since the report. Gold is trading modestly higher, while Bitcoin has risen close to 5%.
Behind the inflation numbers
The sharp decline in headline inflation was largely driven by lower gasoline prices. But there was more good news in the CPI report beyond energy: core prices were unchanged, shelter inflation slowed dramatically, and several categories that have been stubborn sources of inflation moved lower….
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