There are manifold reasons to assume inflation rates are falling. Energy prices and cargo shipping rates are down sharply from their extreme summer peaks. The most notable sign of easing supply chains and disinflationary pressure arrived in October with the non-manufacturing Service sector activity contracting. This created a large drawdown of record backlogs that can ameliorate the risk of recession over the next few quarters. The overly anticipated decline in official inflation indices should now begin. However, for our central bank to actually pause its rapid rate-hiking trajectory, they need a large decline in monthly inflation rates. While the economy is slowing, there is still too much consumer spending. Air travel as measured by TSA checkpoint activity has risen in recent days to equal pre-Covid levels for the first time. This matters to the Fed, but their strongest focus is core personal consumption expenditures, excluding food and energy (core PCE). This index remains near 40-year highs and is being elevated in part by homeowner rent inflation. Rent continues to inflate and has just reached the highest inflation rate of it 38-year history. Once the month-over-month core PCE and rent inflation returns to the upper end of its 0.1 to 0.4% normal range, then the Fed can test the waters by pausing its aggressive credit tightening. For now, it appears to be a lock that Chairman Powell will announce a 75-point hike this week and hint at a 50-point hike in December while communicating a higher for longer interest rate trend well into 2023. This in no way will be a pause or pivot, but it’s certainly possible that hopeful equity investors will twist this into a new Bullish stance by the Fed.

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If the 5-year seasonal pattern in Treasury yields continues to be accurate, then market-determined long yields should continue falling. This hints that the official inflation metrics are ready to start decelerating again at the next Consumer Price Index (CPI) release on November 10th. While rent and wage inflation will prevent a major drop in CPI and PCE this year, the contraction in the widely followed Purchasing Manager (PMI) sentiment for both Manufacturing and Service Sectors for October indicate very weak price inflation pressures. We will also note that Customer Inventories and chip supplier lead times have returned to normal for the first time since Covid began. For stock investors, this bad news in PMI and economic activity is good news short term, as it should prevent upside inflation surprises that we witnessed in the two previous CPI, PPI and PCE reports. While it seems premature for the Fed to state a “pause” in their rate hikes after a 75-point hike this week, these reports will keep investors wondering if the worst part of the recession storm is over, before it even begins. The Fed does not want another Bullish misread by the markets, as occurred over the Summer. A larger rally in stocks along with investors pushing long yields lower (Bonds higher) would be a mistake investors will pay for, if it occurs.

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Back in June, we had forecasted a strong summer rally into August as well as a sharp decline to the lows in early October before yet another rally phase. We assumed the extreme oversold conditions in early October would allow for a 10 to 15% rebound that may peak in the mid-November to mid-December period. With a 12% to 15% rebound in the various indices already registered this past month, our chart below indicates there is room for more. Our technical models remain under the influence of short-term Buy signals with no sign yet of a Sell. With elections next week, it would be understandable for stocks to remain elevated into the midterm election on November 8th. Upward price action into the election is often followed by a spike high and profit-taking should the polls be accurate in predicting a GOP sweep of the House and Senate. Small Cap, Healthcare, Industrials, and military defense stocks have dominated the leader Boards this past month. These sectors have excellent guidance and seasonality into year-end, but they are also very overbought in the short term. Another round of raising cash, partial profit taking or hedging long positions may be warranted over the next month.

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