Inflation has been nothing but full of surprises — remaining persistently hot for the past year when professional forecasters expected it to fade, then turning even lower than broadly expected for July.
The consumer-price index report for last month, released on Wednesday, surprised to the downside — with an 8.5% annual headline rate below the 8.7% forecast of economists and the 8.8% level expected by inflation-derivatives traders. The pain of July’s downside miss was especially acute in the inflation-derivatives corner of the financial market, which has been used to being mostly spot-on about inflation since 2021 — considering millions of dollars can be made or lost on a single trade by being precisely right.
Now, traders of so-called CPI fixings are meaningfully lowering their inflation expectations for the next handful of months. On Thursday, they were pricing in annual headline CPI readings of 8.2% for August and September, down from 8.8% as of earlier this month. Their expectations for October’s reading have also dropped to 7.4%, down from 8%. And even the annual headline rate for December — which traders have been looking toward in order to gauge the effectiveness of the Federal Reserve’s aggressive rate hikes — is expected to drift below 7%, leaving the rate below 2021’s year-end level.
July’s inflation drop “feels a little more sustainable,” said Gang Hu, a 20-year veteran of TIPS and fixings trader who is with New York-based hedge fund WinShore Capital Partners. Near-term inflation forecasting “has become a blind-leads-blind game, as many lead-lag relationships in inflation forecasting were broken” and “intrinsically, forecasting is much harder now.”
Even before Wednesday’s CPI release, though, Hu had begun openly expressing more optimism to MarketWatch about inflation’s downward trajectory, based largely on the impact of falling gas prices. Thursday’s release of the July U.S. producer-price index, which registered its first negative monthly print since April 2020, only added to signs that inflation pressures are easing.
“From a general anecdotal perspective, I don’t think prices are going to go up in the near term at the same speed as we used to have,” Hu said via phone on Thursday. “What gives me a little more conviction now that inflation could trend lower in the next two to three months is that housing and medical care services went down — and that could be a turning point.”
Indeed, a wide swath of CPI categories, including used vehicles and apparel, also turned lower in July versus the prior month, though the most notable declines came in energy costs. Despite the softening price pressures, big-name firms like Pimco and BlackRock Inc. continued to express some worry after July’s CPI data, with Pimco economists saying the annual core measure which excludes food and energy “will likely reaccelerate in August, and isn’t likely to peak until September.”
Read: Stock-market investors cheer July inflation data. Big-name firms like Pimco and BlackRock aren’t so sure.
“I think the jury is still out,” said Tim Magnusson of Minnesota-based Garda Capital Partners, one of the few to anticipate inflation’s persistency last year. July’s CPI number “was a clear miss to the downside, both versus economist expectations and market expectations. We have not seen that in many months, and it must come as some relief to the Fed. That said, there is still reason to believe we could drift higher again on future inflation prints, namely due to the stickiness of rents (OER) and the fact that energy has rebounded a bit.”
The report represented a “substantial downside miss” within the fixings market “so if anyone was ‘long’ that fix, they lost money,” Magnusson wrote in an email to MarketWatch. That, he noted, demonstrates how “trading in the fixings cuts both ways.”
On Thursday, stock investors continued to react to the latest inflation developments, leaving all three major indexes DJIA SPX COMP higher in afternoon trading. Meanwhile, Treasury yields turned mixed as investors weighed the ramifications of the Fed’s next moves.
“Medium term, say in the next five to six months, the whole story is that inflation isn’t over,” said Hu of WinShore Capital. “The inflation pressure we are witnessing in Europe, where 1-year inflation expectations have moved 100 basis points higher, could have an impact in the U.S. And the longer term, say the next one to two years, is not so sure.”