Investment Strategy View: August Inflation

A Challenger Approaches

Once upon a time, in a market environment far, far away, there was a group of investors that were very dependent on the monthly inflation report. They would pore through each individual release for details on where prices may be going, and by extension for an idea of what the Federal Reserve might do. Assets depended greatly on these inflation reports.

If we found ourselves in that same period of time, the August consumer price index release would have probably spooked investors: Headline CPI was in-line with consensus estimates, while the core measure, which strips out more volatile food and energy components, came in slightly hot. Interest rate cut expectations would surely have taken a hit in that scenario, as rates traders would have expected a tougher Fed. But things are different now, and as we discussed last month, inflation has been demoted. There’s a new contender for the mantle of leading market dynamic.

Interest Rates vs. Growth

While there are lots of ways to slice and dice market price action, one way to look at it is through the lens of growth versus interest rate dynamics. Simply put, if Treasury yields and stock prices move in the same direction, it suggests that growth dynamics are in the driver’s seat. If they move in opposite directions, it suggests that interest rate dynamics are in the driver’s seat.

Interest rate dynamics were king in recent years, as hot inflation led to investors expecting a tougher Fed, pushing Treasury yields higher and stocks lower. Immediately after the August CPI release, it looked like that was what we were getting once again as 2 and 10-year yields spiked by 10bps and 5bps, respectively, while stocks fell. It seemed as though the old environment was back – but it didn’t last long.

Stocks and yields both fell in the early hours after U.S. markets opened. That Treasurys would rally (i.e. yields going down and prices up) as stocks struggled is classic risk-off behavior. Investors, worried about the trajectory of the economy and earnings growth, rotated into the perceived safety of government securities. And when yields generally moved higher for the remainder of the trading session, stocks followed them higher in a risk-on manner, making it clear that growth dynamics were ultimately in charge.

The Fall Is Here

Against this backdrop, there are still some worries about the possibility of a brewing recession. That might sound counterintuitive. How could a recession be a concern when inflation came in more hot than cold and the Fed is about to begin lowering interest rates? The answer is: It’s complicated.

Much of what drove the upside surprise in inflation was an uptick in housing costs. That component of the index tends to be very slow-moving and reflects both structural factors – such as the housing shortage – as well as cyclical economic conditions.

Since the July jobs report that came out in early August, investors have been worried that the Fed is behind the curve and that monetary policy is still too restrictive even though it’s expected to start easing up this month. That’s why some were hoping that the Fed would get the ball rolling by lowering rates faster than the usual 25bp increment.

Whether the Fed cuts rates by 25bps or 50bps next week, they’re still cutting. And while the fall season brings cooler air, the hope is that it doesn’t bring a colder economy with it, but it’s too soon to be confident on that front. That suggests that sticking with what has worked over the last few months – defensive sectors, dividend payers, Treasurys, and the 60/40 portfolio to name a few – could be a prudent move.

Communication of SoFi Wealth LLC an SEC Registered Investment Adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at www.adviserinfo.sec.gov. Liz Young is a Registered Representative of SoFi Securities and Investment Advisor Representative of SoFi Wealth. Her ADV 2B is available at www.sofi.com/legal/adv.