Last summer, I had written about ‘why I think inflation is far from peaking‘ and I was of a belief that inflation won’t come down to Fed’s 2 percent target anytime soon. It’s been almost 3 quarters since then and we have seen inflation almost halving from 9.1 percent in June 2022 to 4.9 percent in April 2023. Although the headline numbers are far better compared to what we saw last year, there are some key questions that need to be answered. Is the peak inflation behind us? Has Fed done its job of raising interest rates and brought us back in the game? What if it leads to deflation? What about recession? Is it coming? Soft landing or hard? We’ll try and tackle as many of these as we can.
We do that by looking at some key indicators. Starting with PPI:
That sharp decline in producer prices from the peak of March 2022 when they hit a high of 11.7 percent is quite a sight to see. While the rise from the troughs too was steep, thank to covid related supply shocks and Russia-Ukraine war related bottlenecks, those issues seem behind us and visibly, these lower producer prices are here to stay. More so, at current high interest rate environment, companies would find it difficult to raise their prices in the near future, more so if and when recession hits us. Now lets take a look at CPI+Core:
CPI and core CPI still seems elevated but there’s something worth noting: CPI usually lags PPI by few months at least by a quarter, if last year’s peak is any indication. Given the sharp downtick in PPI in last one year from 11.7 percent to a comfortable 2.2 percent, we shouldn’t be surprised if CPI ends up comfortably around 2-3 percent in the coming 3-6 months.
Isn’t that something to cheer about? Yes and no.
While, lower consumer prices are indeed a relief for the consumer, Fed is definitely not budging on rate cuts anytime soon, at least not in its June meeting. Fed is looking for job losses and CPI of 2-3 percent before lowering rates. The lagged effects of higher rates of last 18 months, have started to tickle down into the economy and it is the question of when and not if the recession hits us.
Recessionary times are difficult to predict and wade through. Companies would be forced to keep prices low to stay afloat in low demand environment. While the end user would be happy to see lower prices, uncertainty about the jobs would keep them on tenterhooks to not loosen their purse strings. End result? Even lower prices.
In no time, I assume companies would be lowering prices lower than what they had last year – a deflationary scenario! PPI would be the first to show signs of cracking, CPI would only follow in times to come.
Macro conclusion: Next two quarters would be as interesting as the whole of last year when markets continued to fall as inflation continued to rise and Fed continued to raise rates. Sector that performs worst in deflation? Banks!
Micro view: Out of curiosity, I was going through charts of some of the bank names and was shocked to see what was visible: A disaster waiting to happen for bank names. Here’s a gist of some of those names:
Metropolitan Bank (MCB):
ZION:
Comerica (CMA):
Bank of Hawaii (BOH):
KBW Nasdaq Bank index (BKX):
While these are a few names, there were many more that I had shared on my Twitter feed.
I have always believed that markets know a thing or two that we don’t and hence there is a reason why it is called as a discounting machine. It discounts things even before we know it. That brings me back to deflation – are banking names starting to reflect deflationary fears already in the price? We would know in time, but for now it would be wise to follow the price action.
Macro micro trader 
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