The great inflation debate

Good news! We may be past the worst of the inflation crisis.

Inflation slowed down for the first time in a while last month, with year-over-year Consumer Price Index growth moderating to a still-scorching 8.5% (from 9.1% in June).

Yes, we’re moving in the right direction. But the job may not be done yet. Inflation is still unusually hot, and there are signs it could stick around for a while.

If you’re an economist, you’re probably still gritting your teeth over July’s CPI reading. For investors who’ve been waiting for months to see peak inflation, the trend may matter more than the number.

It’s a fair debate, and to be honest, both sides have a point.

The number: not so great

Inflation has been an evolving problem for months. We’ve gone from expecting “transitory” inflation from supply chains to watching our grocery bills and rent rise consistently. We’ve seen a handful of CPI reports that Wall Street expected to be “peak” inflation, only to see experts underestimate the numbers once again.

So when gas prices started falling, investors’ attitudes toward inflation changed dramatically. From July 13 — the date of the June CPI report — until Wednesday, the S&P 500 rallied 8% and tech stocks climbed 10%. Peak inflation seemed like a done deal, and the July CPI may have confirmed it.

You can’t blame people for getting excited about this number. Inflation may finally be slowing down, and that trend could eventually help your portfolio and your wallet turn around a dismal year.

You have to wonder, though: Are we getting a little too excited? The fever is breaking, but inflation is still far from OK. 8.5% price growth is still historically high. To put it in context, 8.5% annual inflation will cut your savings in half in eight years. That rate of change can still easily impact Americans’ spending habits and portfolio preferences.

The assumption is that inflation will slow even more over time, but will it happen quickly on paper and real life? Wall Street doesn’t think so, with most economists surveyed by Bloomberg predicting that year-over-year CPI growth will still be 7% or above at the end of this year. 

Plus, there are plenty of signs that inflation isn’t improving in certain areas of the economy. One detail that caught my eye in July’s CPI report was that inflation in services — rent, medical bills, insurance payments — is still accelerating. Services prices tend to be stickier (or change at a slower rate) than goods prices. So while inflation may have peaked already, it could stay stubbornly high for a while with services demand so strong. Rent inflation is also especially troubling, and it may not subside easily with the housing market cooling down.

So don’t get too far ahead of yourself. Inflation may still be an issue, and the Federal Reserve knows that.

The trend: getting better

Speaking of the Fed, there are two sides to this story: inflation, and how the Fed views inflation. Stocks and crypto have rallied because inflation may be peaking, but also because the Fed may be satisfied enough that they choose to stop hiking rates. Higher rates and inflation have crushed stocks and crypto, especially more speculative names. By the way, here’s why that’s happening.


This is where the trend is important. A peak in inflation may signal a peak in the Fed’s policy rate as soon as the first half of next year, at least according to investors in Fed fund futures. Presumably, rate cuts would start because the job market crumbles, or because inflation is under control. Put it all together, and people feel confident that this peak is the first in a monumental inflation slowdown that allows the Fed to pivot.

This isn’t a crazy thought, especially if the Fed looks at history as a guide. In 10 out of the past 12 hiking cycles, the Fed has cut rates within a year after CPI growth has peaked. There’s also something to be said for how slowing inflation changes the market’s makeup. Now that we have some evidence inflation is coming down, investors could naturally turn back into parts of the market that were crushed by higher rates. In fact, it’s already happening.

But like I said earlier, inflation may not come down significantly any time soon. In the Fed’s eyes, high inflation may matter more than the trend. In fact, they have a (dated) inflation target of 2% year-over-year price growth to think about when considering rate hikes. As long as inflation stays unusually high, the Fed has a good reason to keep hiking. That is, unless we fall into a recession, and then you could have a drop in earnings and employment to worry about.

Optimistic markets are starting to prepare for the end of rate hikes. Still, we may be underestimating just how aggressive the Fed could be if inflation stays at these levels. It’s easy to get caught up in the trend, but the level of inflation could matter more for monetary policy.

The truth: it’s complicated

This week’s CPI report is worth cheering about. The trend is moving in the right direction. But we’re still far into the woods, and we may not make it out for a while. Your bills may keep increasing at a noticeable rate, which demonstrates exactly why the Fed might opt to hike more. Inflation is slowing, yet prices are still rising quickly.

In this environment, it’s tricky to know just how much to lean into a rally that looks increasingly out of touch. Markets may be looking ahead, but the Fed could remind us just how dire the inflation situation still is.

It’s a weird world out there, and a lot of us are used to quick recoveries back to the highs. Will it be as easy this time around? Slowing inflation and demand may bolster the case for growth over value, but there are still a lot of questions surrounding the future of tech and crypto. Don’t get too caught up in the speculative fervor just yet.

Think about how to stay protected in case the market turns, while staying properly exposed to risk so you don’t miss the early days of a recovery. Tread carefully as we make our way down the inflation mountain.

*Data sourced through Bloomberg. Can be made available upon request.