Receive free US updates with our myFT Daily Digest email, delivering the latest US news every morning. Welcome to Unhedged, I’m Ethan, and Rob will be back tomorrow. Are we already factoring in all the positive news? According to Morgan Stanley, this earnings season, the response to earnings beats has been relatively lackluster compared to historical trends. However, there is one noteworthy exception: Berkshire Hathaway. After Saturday’s earnings report, the company’s stock rose 3.4%. It’s worth noting that Unhedged previously expressed doubt about Berkshire’s sustainable ability to outperform the S&P 500. Readers can now make their own assessments. Feel free to email me your thoughts at [email protected].
Now let’s discuss a somewhat complex concept related to inflation: “base effects.” Although it may seem trivial, it’s actually quite important to understand. Inflation is a measure of change, and the denominator used for measurement plays a significant role. The two common methods are month-over-month and year-over-year comparisons. The tricky part is that while monthly rates can remain flat, annual rates can still show an increase. This is because the effects of prices from a year ago still impact current prices.
Although it may seem complex, this concept is crucial. The most significant increases in inflation occurred in the first half of 2022. Consequently, the base effects of slower rising denominators will likely boost annual inflation comparisons for the rest of this year’s CPI reports. The prevailing market narrative of a soft landing is partly based on the current annual inflation rate of around 3%. If this rate starts to rise, even if it reflects a modest monthly increase, investors may begin to question their assumptions about the expected disinflation trend.
Research Affiliates, in a recent post by Rob Arnott and Omid Shakernia, highlighted this point. They predicted an illusion of declining inflation in the first half of the year, potentially falling below 3% by mid-year. However, they also pointed out the possibility of a surge in inflation in the second half of the year due to shifting base effects. They provided a chart to illustrate this, showing the potential range of annual inflation rates based on different monthly CPI readings.
Bank of America also addressed this issue in a chart that gained attention in July. However, Omair Sharif of Inflation Insights argues that BofA’s chart is misleading because it uses non-seasonally adjusted monthly rates. When using seasonally adjusted numbers, the threat of base effects appears less significant. Sharif provides an alternative chart that more accurately represents the situation.
In the coming months, base effects should be less of a concern, especially when focusing on core inflation. Carl Riccadonna, chief US economist at BNP Paribas, suggests that energy base effects are the main factor to consider. Instead of fixating on year-over-year trends, he advises paying attention to core inflation and its monthly readings. However, the real issue is not a sudden surge in inflation but the possibility of it settling at a persistently high level. Monthly core inflation readings in the next couple of months may appear encouraging due to factors like disinflation in shelter and used cars. However, Sharif believes that over the next year, core inflation will likely fluctuate between the high-2s and 4% in annualized terms.
Matt Klein, writing for The Overshoot, expresses a similar view. He argues that without a downturn, it is unclear why wage growth would decelerate enough to bring inflation back to the Fed’s 2% goal. He suggests that underlying inflation may be closer to 4% than 2% due to consistently high wage growth. Rising wages sustain consumer spending, and falling prices may only serve to increase purchasing power, leading to higher demand and ultimately higher prices.
Sharif provides an example from the used-car market to illustrate this point. In the second half of 2022, used-car prices steadily declined. However, in January, there was a sudden surge in demand due to lower prices and substitution from new cars. This caught dealers off guard, and they had to rush to wholesale auctions, leading to a significant increase in inflation a few months later.
Inflation can only fall as far as consumer spending allows it to. While the threat of inflation to the markets may not have disappeared, it is important to consider the ongoing relationship between wages, prices, and consumer demand.
Now, let’s move on to a recommended read: a book review discussing the divide between George Orwell’s rhetoric and his personal life.
Don’t forget to check out our new podcast, the FT Unhedged podcast, hosted by Ethan Wu and Katie Martin. It offers a 15-minute deep dive into the latest market news and financial headlines twice a week. Missed a previous edition of the newsletter? You can catch up here.
For more expert insights on the intersection of money and power in US politics, we recommend subscribing to our Swamp Notes newsletter. Additionally, if you want to stay informed about local and global investment trends, sign up for The Lex Newsletter, written by expert writers in four major financial centers.
Denial of responsibility! VigourTimes is an automatic aggregator of Global media. In each content, the hyperlink to the primary source is specified. All trademarks belong to their rightful owners, and all materials to their authors. For any complaint, please reach us at – [email protected]. We will take necessary action within 24 hours.
