Inflation decelerated faster than expected
US CPI for July came in lower than expected, with headline CPI coming in flat for the month (consensus 0.2%), and year-on-year rate dropping to 8.5% from 9.1% in the previous month. Core CPI, which excludes food and energy rose 0.3% month-on-month (consensus 0.5%) while the year-on-year rate stood at 5.9%, similar to the previous month.
While inflation has cooled down a little relative to the previous month, it still remains much higher than the Fed’s target rate. Taking a closer look at the constituents, much of July’s decline can be attributed to a decrease in commodity and energy prices due to fears that an aggressive central bank policy might push the economy into a recession, dampening global demand (Figure 1).
Figure 1: Headline CPI dropped to 8.5% year-on-year in July
Following the lower-than-expected inflation print in July, the S&P 500 index extended its rally, and is now up by more than 15.68% since hitting a year-to-date low of 3636.87 back in 17 June. The positive market reaction is likely due to sentiment driven traders betting that inflation has peaked. While this is possible, we do not think that inflation may come down as quickly as investors expect, and could remain sticky at the 4-5% range for the medium to long term.
Is it time to buy US equities?
While July’s CPI print paints a slight positive outlook that inflation may be under control, we believe investors should remain cautious. Drawing similarities to a case not too long ago, there was also an instance back in April 2022 when CPI came in lower than in March but climbed higher in May and June. Therefore, we believe that investors should not place too much emphasis on a single economic data point but rather look for more evidence over the next few months for more confirmation on whether inflation is truly getting under control.
Furthermore, two Fed officials have come out after the CPI print and reiterated that they will continue to tighten monetary policy until price pressures are fully under control. In view of this, we believe the Fed may not cut rates as early as the markets are hoping for in 2023. More insights could be drawn from the upcoming jobs and inflation report before the next FOMC meeting in September.
Even though inflation seems to be trending in the right direction, we reiterate that investors should not read too much into current numbers and short-term data, but rather take a holistic and longer-term approach while also looking at the underlying fundamentals of companies and the economy.
In addition, investors should also pay close attention to valuations. Despite share prices coming down significantly this year, valuations in some sectors still remains stretched and could present further de-rating risks if earnings expectations are not met.
Setting aside short-term price action and emotions, with the recent negative earnings revisions and lowered guidance by corporates, we believe that even with inflation falling, the US economy is at risk of a recession, especially if the Fed continues to tighten rates aggressively.
In conclusion, we continue to underweight US equities and prefer relatively more attractive regions like Asia ex-Japan and China. If investors are still keen on investing in US equities, they could opt for a value tilt which should benefit in a rising interest rate environment.
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