Earlier this week, we saw the Consumer Price Index (CPI) report was down from last month and generally well below expectations—in this case, a good thing. Today, we got the Producer Price Index (PPI) report, which was also down from last month and less than expected. Inflation appears to have peaked and is potentially on track to decline.
This is good news. But I don’t want to get into the details of the numbers here. Instead, I’d like to think about how to interpret economic news in general, especially with respect to the headlines and what this data means for the future. Headlines tend to scream that inflation is at 40-year highs, which is certainly important in one sense. But as an economist and investor, that information is useless, as it is already in the markets.
The Real Question
For any data release, record or not, the real question is not where it is, but where it is going. To think about that, we can’t just look at the current number. We also have to look at last month and last year. The real question is whether things are getting better or worse. Beyond that, are they getting better or worse at a faster or slower rate? The actual number doesn’t mean that much when we look at the future—and that is how we have to look at this month’s data.
To put this in context, if you are driving 30 mph, will you get a ticket? Maybe, but it depends on whether you’re in a school zone or on the interstate. Context matters. Apart from getting a ticket, are you happy to be driving at that speed? Again, it depends. If you were doing 60 mph and had to slow for traffic, probably not. On the other hand, if you were in stop-and-go traffic and doing 10 mph when the traffic opened, you probably would feel a lot better about 30 mph. It’s not the number; it’s what it means in context.
Big Change, Not a Big Surprise?
This brings us back to inflation. Yes, inflation is down, but it is still quite high. Is that good or bad? Probably good, despite the fact that it remains high. The difference is that now it seems to be moving down rather than up. That matters more than the fact that it is still high. That change in trend is what markets are responding to. We have gone from things getting worse to things getting better. Regardless of the current numbers, that is a big change.
It isn’t that big of a surprise, either. The underlying inflation data was slowing in prior months, still increasing but at a slower rate, suggesting that reasonably soon we would see the overall trend change. You have to decelerate to a stop before you go into reverse, to go back to the driving metaphor. So when you see that deceleration, you know to look for a reversal. This is the real basis for all of the forecasting we as investors have to do: not what the number is, but where it is going—and how quickly.
That suggests more good news for inflation. It is still too high, but now the trend has changed from up to down. While it will likely take time for it to fully cool—and inflation will likely never return to the pandemic lows—the worst cases are moving off the table.
A Look Ahead
So, don’t look in the rearview mirror at the headlines, but to where we are now and where we are going. The headlines are still scary, but the future now looks a lot better.
Authored by Brad McMillan, CFA®, CAIA, MAI, managing principal, chief investment officer, and Sam Millette, manager, fixed income, at Commonwealth Financial Network®.
© 2022 Commonwealth Financial Network®
© Axial Financial Group. All Rights reserved. 5 Burlington Woods, Suite 102 Burlington, Massachusetts
Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index. The Bloomberg US Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year. The U.S. Treasury Index is based on the auctions of U.S. Treasury bills, or on the U.S. Treasury’s daily yield curve. The Bloomberg US Mortgage Backed Securities (MBS) Index is an unmanaged market value-weighted index of 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (FHLMC), and balloon mortgages with fixed-rate coupons. The Bloomberg US Municipal Index includes investment-grade, tax-exempt, and fixed-rate bonds with long-term maturities (greater than 2 years) selected from issues larger than $50 million. Basis points (bps) is a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1 percent, or 0.01 percent.