Why Wall Street is OK with a little sticky inflation
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Consumer prices are up 2.9% year over year, according to the latest Consumer Price Index, which led stocks to rally as investors believe this level of inflation still allows the Federal Reserve to cut interest rates.
Why it matters: As long as consumer spending holds up — a big if — cutting rates amid elevated inflation can be a Goldilocks bull case for stocks.
What they're saying: "The numbers that we're looking at today are actually pretty good," said Savita Subramanian, head of U.S. equity and quantitative strategy at BofA Securities, as inflation was heating up again this summer. "They're kind of Goldilocks."
Catch up quick: Typically, the Fed raises rates to tackle inflation, in hopes that raising the cost of money will curb spending and therefore demand — and ultimately, prices.
- But the labor market is buckling, and that usually pushes the Fed to cut rates to spur growth.
- Fed chair Jerome Powell has indicated a near-term focus on the labor market over inflation.
- Investors are pricing in three rate cuts this year as a result.
Between the lines: Here's why that could be the dream scenario for investors.
- If prices on goods keep going up, and the Fed prevents mass layoffs by cutting rates, consumers may be able to keep pace with inflation.
- That would likely translate to earnings growth, and therefore higher stock prices.
- This is part of the narrative that has driven the stock market to record highs this week.
Yes, but: This is an economic tightrope that's incredibly difficult to cross without falling over.
- Renaissance Macro Research's Neil Dutta said that the Fed is already too late in cutting rates and that the economy is already slowing.
- That would mean consumer spending could slow further while prices are rising.
- That's a toxic combo for earnings growth.
The bulls would say consumer demand has not shown signs of slowing, citing the latest quarterly earnings for companies and retail sales numbers.
- Rate cuts will only fuel more spending, in their view.
Zoom out: This kind of backdrop — accelerating inflation, slowing job growth — requires different hedging strategies for investors, Arnim Holzer, global macro strategist at Easterly EAB, tells Axios.
- He believes volatility could spike, and since bonds and stocks are now moving in the same direction, investors can't count on the former as a hedge against the latter.
- Alternatives like private credit or even gold, which continues hitting records, could be the way for investors to diversify in this environment.
What we're watching: The consumer, who drives two-thirds of GDP growth.
- The spending patterns of you and your friends could determine whether the market bulls or bears are proven right.
