November 11th, 2022
Voters headed to the voting booths on Tuesday for one of the most hotly contested midterm elections in history. Polls heading into the election suggested a “Red Wave” might be in the works, similar to the 1994 and 2010 midterms where Republicans gained 54 and 64 seats, respectively. Wall Street placed wagers on Monday and Tuesday that the election would yield a strongly divided government, resulting in gridlock for the Biden agenda. While the final results have yet to be certified, voters’ dissatisfaction with the economy and inflation managed to only translate into a red ripple with Republicans taking the House by a narrow margin but likely failing to retake the Senate. Fortunately, the news cycle moves fast, and Thursday’s Consumer Price Index (CPI) report reversed Wall Street’s disappointment with the election outcome. The October CPI registered a 7.70% year over year increase. That was its slowest annual rise in nearly a year and well off this year’s peak of 9.10%. The report sent both stocks and bonds skyrocketing higher on Thursday as investors scooped up interest rate sensitive names from growth to discretionary stocks on hopes the Fed would halt its rate hiking campaign due to the cooling inflation figures. The S&P 500 finished the week up 5.90% for its best week since June.
Market Bets Inflation Has Peaked
Inflation has been the top issue for markets this year, and the Fed’s tightening policy appears to finally be making its way through the economy, dampening both demand and prices. In October, the Consumer Price Index rose 7.70% from the year ago period. That was down from September’s 8.20% annualized increase. Core prices, which exclude volatile food and energy, rose 6.30% from the year ago period, down from September’s 6.50% annualized rise. Month-to-month figures also slowed. Core price growth slowed to a 0.30% gain (essentially a 3.6% annualized run rate) in October from 0.50% (6.0% annualized run rate) in September. A drop in prices for natural gas, used cars, and medical services drove much of the price decline in October. The rising cost of borrowing in particular has taken a toll on used car sales, pushing prices down -2.40%. Used car buyers are suffering from financing shock, paying an average used car loan rate of 9.60% in October. While October’s CPI figures showed progress on inflation, we could see prices rebound once again in December due to seasonality effects. An unusually cold weather pattern is expected to blanket the lower 48 next week and linger, leading consumers to turn up the thermostat and resulting in higher natural gas prices due to higher demand. Medical care costs also look set to rise next month as consumers make a rush for year end services before higher deductibles and premiums kick in next calendar year. Medical care costs could also prove particularly sticky next year and beyond. Historically, medical care costs have risen faster than inflation. Yet, that has not been the case this year as many individuals put off treatment due to concerns over Covid. That’s led to lower healthcare spending and slower medical cost growth relative to inflation. With individuals now back to their doctors’ offices and Covid induced demand for healthcare labor still high, medical care services costs look set to outstrip inflation once again.
Final Thoughts
Markets had been rallying strongly coming into this week, confident that the election would hand Republicans control of Congress and put a check on the White House’s agenda. That didn’t pan out exactly as most expected, and while the root causes for the poor performance have big implications for Republican prospects in 2024, investors were clearly disappointed. At the risk of sounding partisan, which is not our intent, if Republicans do manage to gain control over the House but fail to take the Senate (as it looks right now), that may actually be a blessing in disguise. Wall Street will get its gridlock on major legislation, and Democrats will still own the economy. That may sound counterintuitive given how the market responded to Thursday’s CPI report. The CPI report and comments by the Philadelphia Fed President Patrick Harker suggest that the Fed will soon shift the pace of rate hikes once the Fed Funds rate gets to 4.50%. Markets, however, reacted as if they heard that the Fed only has one more, 0.50% hike left in it before pausing. Harker is not a voting member of the FOMC, and while his message was consistent with Powell’s own comments saying that the Fed will be data dependent in assessing the pace and magnitude of rate hikes going forward, the market likely got ahead of itself both in terms of what this CPI report really means and in just how significant Harker’s comments really are. One the one hand, we do agree that this week’s CPI report shows we are probably well beyond peak inflation, and if the market was simply expressing relief or acknowledgment that the inflation problem is controllable then we get that. We said last week that markets were spring loaded for just this type of reaction, but investors need to be sober about what lies ahead. The Fed’s messaging has been not just that rates are going higher, but that they are going to be higher for longer. Food, services, and shelter – all major costs to individuals – are still all running north of 6.00%. So, while the Fed may slow the pace or magnitude of future hikes as it sees progress on inflation, there is still a lot more to be done to get inflation back to the 2.00% target, and the terminal rate is still probably higher than the 4.50% figure that the market has seized upon. Ultimately, solving the inflation problem probably results in a manufactured recession which is a problem Republicans might be happy not to own when it comes time for the 2024 campaign season.
The Week Ahead
It will be a busy week as we round the corner to Thanksgiving. Consumers take center stage with the release of October retail sales figures. Amid high inflation and excess inventory, retailers are hoping consumers are getting an early jump on holiday shopping to score deals and boost retailers’ bottom lines. Traders will also pour over the latest existing home sales and housing starts figures. Given the Fed’s rate hikes, it’s expected to be another round of tough reports. Producer prices round out the week’s economic data. A further drop in prices at the factory gate could ignite bulls’ optimism that we have seen the peak in inflation.
Veterans Day 2022: Honoring Those Who Served
Today is Veterans Day, a holiday that honors the men and women who have served, or are serving, in the U.S. military. The holiday was originally called Armistice Day to commemorate when the armistice, or cessation of hostilities, between the Allied nations and Germany went into effect during World War I — on the eleventh hour of the eleventh day of the eleventh month of 1918, signaling the unofficial end of World War I. This is why Veterans Day is celebrated on November 11th each year. It was originally proclaimed by Woodrow Wilson in 1919 with the words, “To us in America, the reflections of Armistice Day will be filled with solemn pride in the heroism of those who died in the country’s service and with gratitude for the victory, both because of the thing from which it has freed us and because of the opportunity it has given America to show her sympathy with peace and justice in the councils of the nations…” In observance of the holiday, all business was suspended for two minutes starting at 11 a.m. and parades and public gatherings were held to commemorate the occasion.
Armistice Day became a federal holiday in 1938, primarily to honor those who served in World War I. Following World War II in the 1940s and the Korean War in the 1950s, the name of the holiday was changed to Veterans Day to memorialize all veterans. The holiday also honors America’s unknown soldiers. At 11 a.m. every Veteran’s Day in Arlington National Cemetery, a combined color guard representing each branch of the military executes a “Present Arms” at the Tomb of the Unknown Soldier. The nation’s tribute to its veterans is also symbolized at this time by the laying of a wreath at the tomb.
The U.S. Census estimates that there are approximately 18 million veterans living in the United States, with more than 16 million of those having served during times of war and with 1.3 million active duty service members. Today, the U.S., as well as several other countries, will be celebrating holidays to honor their veterans, and we hope everyone will have an opportunity to participate in these occasions and remembrances or simply to thank a veteran in recognition of their service.
Probity Advisors, Inc. extends our gratitude to all past and current members of the military and their families for their courage, strength, and sacrifice. We are thankful for your service and for protecting the freedoms we cherish.