Inflation is still way too high, Russia is still in war against Ukraine, and mortgage rates are still 2.5 percentage points above where they were a year ago. Yet, the equity markets have rallied quite a bit since June. The S&P 500 Index is up in double digits since June 16 and, as of today, retraced a good deal of its decline and is now over halfway back to its all-time high. So, what supports a rebound like this? In this latest edition of LPL Street View, Chief Economist Jeffrey Roach lists a few reasons why investor appetite has approved.

First, consumer inflation is showing signs of easing. The Headline Consumer Price Index (CPI) eased in July to 8.5% year-for-year from June’s 9.1%, still above the Federal Reserve’s (Fed) long-run target rate. While the annual rate of inflation does seem to be cooling, inflation is especially easing for durable goods as prices continue their descent from recent highs. For example, prices for appliances have declined for three out of the last four months. Similarly, used vehicle prices have declined four out of the last six months. The July Inflation Report changed the market’s expectations about future Fed activity, and as inflation eases, the Fed can tighten monetary policy at a slower pace. Though the Fed still has a lot of work to do, pricing pressures seem to be easing.

Second, falling import prices are evidence that pricing pressures are easing overall. A strong U.S. dollar is bolstering the buying power of domestic firms, which likely explains some of the declines in import prices. Though it should be pointed out that imported food and beverage prices declined for three consecutive months in July. This is likely the beginning of a long process of overall prices normalization. Falling prices for imported food and drinks are especially encouraging given the ongoing disruptions in Ukraine, a key exporter of agricultural commodities.

Third, producer prices fell in July, pulling down the year-over-year rate of growth from the extremely fast growth rates earlier this year. We expect producer prices to ease as supply chains improve, but it will likely take some time before the inflation pipeline cools down to levels acceptable to the Fed. What may best explain the recent uptick in investment appetite is the market’s favorable response to this data, and the markets being comfortable in their belief that the Fed can stick a soft landing.

 


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