Will the aftershocks of the “repeated CPI shock” continue? Policy interest rate outlook is the key

Written by:  Mutsumi Kagawa (Chief Global Strategist, Economic Research Institute of Rakuten Securities)



1. US stocks plunge as interest rates rise along with repeated CPI shocks

US stocks, which recovered from the previous week, fell sharply after the CPI (August Consumer Price Index) growth announced on the September 13 exceeded expectations. Chart 1 shows the trends of major stock indices representing the US market (S&P500 index, NY Dow Jones Industrial Average and Nasdaq Composite Index) since the beginning of the year. The stock price indices which were bearish until the end of June, bottomed out, but became unstable again in response to hawkish remarks by senior FRB officials and expectations that inflation will remain high. In this article, I will provide an overview of the CPI and PPI (Producer Price Index) announced for August, which the market has been paying close attention to this week. On the other hand, I would like to explore future interest rate trends and stock market trends, based on the situation in which consumer inflation expectations are declining and the outlook for policy interest rates in the futures market. I generally believe that US inflation will ease heading towards next year even if there are twists and turns along the way, and the market is gradually factoring in the rate increase expected by the futures market (additional interest rate hike of around 1.50% within the year). The market is already focusing on the FOMC (Federal Open Market Committee), which will be held on next week 20th and 21st. If there is a sense of relief that the “event”, including the decision to raise interest rates further has passed, and bond market interest rates (yields) stabilize after the FOMC, I foresee the stock market to regain stability.



2. What are the results of the August inflation indicators?

Chart 2 shows the growth of the overall index and core index (price index excluding energy and food) from 2019 onwards for the growth rate of CPI and PPI (year-on-year), which are representative price indicators. The US Bureau of Labor Statistics released the CPI for August on the 13th and the PPI for the same month on the 14th. After reaching the highest level in about 40 years at +9.1% in June, the CPI growth rate slowed to +8.3% in August from +8.5% in July but exceeded the forecast average (+8.0%). In addition, the growth rate of the core index increased to 6.3% from the previous month. Gasoline and other energy prices fell, but the outlook for policy interest rates in the futures market and interest rates in the bond market rose due to concerns about rising service prices, which are affected by housing costs (imputed rent) and wage increases. It can be said that the event called the “CPI shock” experienced in June has returned. However, the slowdown in PPI growth from the previous month generally indicates a slowdown in the inflation rate in the upstream sector, and inflationary pressures are generally expected to ease gradually into next year.



In fact, the latest “consumer survey” released by the Federal Reserve Bank of New York on September 12 revealed that “inflation expectations” are declining (Chart 3). According to the same survey, “inflation expectation 1 year later” dropped to +5.75% (+6.22% in July). “Inflation expectation 3 years later” fell to +2.76% in August (from 3.18% in July). In particular, “inflation expectation 3 years later” declined for the fourth consecutive month, after peaking out in September 2021 (4.19%) and October 2021 (4.21%), and after January this year, it subsided to about 3% and around 2% in August. The above-mentioned slowdown in the growth of major price indexes and the decline in consumer inflation expectations are likely the tailwinds for the monetary authorities, which emphasize controlling inflation over the medium term. If inflation expectations continue to stabilize and uncertainty over the policy rates eases, the 2-year bond interest rate (3.7%) and 10-year bond interest rate (3.4%) should stabilize.



3. Market is shaken by changes in policy rate outlook

FRB raised the policy rate (maximum target of the FF interest rate) by a total of 2.25% (0.25% → 2.50%) at the 4 FOMC meetings from March to July to curb inflation. In response to these interest rate hikes, interest rates (yields) rose in the bond market. According to the latest forecast of policy interest rates calculated in the futures market, the FF interest rate after the December FOMC is expected to be around 4.02% (Chart 4). With the current FF interest rate at 2.5%, this suggests that the market expects an additional 1.50% (125BPS) rate hikes at the FOMC meetings in September, November, and December. In other words, the market may have factored in the FOMC’s decision to raise interest rates by 0.75% at the FOMC next week, 0.50% at the FOMC in November, and 0.25% at the FOMC in December. The FF interest rate forecast for December 2023 fell below the forecast for December 2022 from July to August, temporarily making the market aware that the interest rate would be cut next year. However, the “Jackson Hole Shock” has put those expectations to rest. Recently, the policy rate for 2023 has changed to a level that the policy rate will remain unchanged (or to be cut after an additional rate hike: the policy rate in December 2023 will be at the same level as December 2022). Regarding inflation, it is widely believed that global supply chain disorder is the factor in supply constraints, leading to higher prices in the upstream sector. For reference, the “Global Supply Chain Pressure Index” announced by the Federal Reserve Bank of New York is declining (June=2.32 → July=1.75 → August=1.47), and this indicates that price increase pressure associated with supply constraints is easing. At the FOMC meeting next week, the FRB will announce the latest economic and interest rate outlook after deciding to raise interest rates further (expecting additional 0.75%). As long as there are no major surprises, including FRB Chairman Powell’s press conference, I believe that the “relief from passing the event” will likely support the stock market.