Wall Street investors grapple with how ‘last mile’ of U.S. inflation will play out

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Inflation’s likeliest trajectory continues to be one of the most important questions facing financial markets and is becoming more difficult to gauge heading into what some say may be its final stretch.

Raising a glimmer of hope for a quick and dramatic fall in U.S. inflation during the months ahead was Tuesday’s data from Canada, which showed the country’s consumer-price index easing on a 12-month basis in May to 3.4% or its slowest pace since mid-2021. U.S. Treasury yields briefly dropped after the report, led by the policy-sensitive 2-year rate
before reversing on healthy U.S. data.

Many in financial markets remain optimistic that U.S. inflation can fall back toward 2% as soon as this year — including traders of derivatives-like instruments known as fixings, who have been closer to the mark than others. As of Tuesday, they saw the annual headline rate of the U.S. consumer-price index producing 3%-level readings from June to September — down from 4% in May — before dipping to 2.7% for October.

Economists at mutual-fund powerhouse Vanguard Group said they think inflation is on its “last mile” or “last leg” toward most central banks’ targets of around 2%, which won’t likely be reached until late 2024 or 2025.

“The market is trying to find its footing as to what the direction of monetary policy is going to be from here,” said Mark Heppenstall, president and chief investment officer of Penn Mutual Asset Management in Horsham, Pennsylvania, which oversaw $31.4 billion in assets as of May.

“The next phase as to how to navigate sticky, durable inflation to target is going to be harder. Given the uncertainty of the market, money is starting to navigate into high-quality fixed income, which acts as a stabilizing mechanism, because income and yield are there. It’s a good place to park capital, especially when rates are elevated,” he said via phone.

The next major U.S. inflation report arrives on Friday, when the Federal Reserve’s favorite gauge, known as the personal-consumption expenditures price index, is expected by economists to show its narrower core reading fell in May to 0.3% on a monthly basis and 4.6% year-over-year. Meanwhile, core measures of the separate consumer-price index, or CPI, have been stuck at 0.4% for three straight months and above 5% on a 12-month basis as of May.

Tuesday’s U.S. data batch — including May’s durable-goods orders and new-home sales, plus consumer confidence for June — came in better than expected, creating a counterargument that the world’s largest economy may still be much too strong to put a meaningful dent in inflation.

Outside North America, inflation has proven to be stubborn. Britain’s inflation rate remained stuck at 8.7% in May. And while the eurozone’s level slid to 6.1%, the price of food and services still increased at an uncomfortable pace. On Tuesday, European Central Bank President Christine Lagarde said inflation is still too high and “set to remain so for too long.” And Gita Gopinath, deputy head of the International Monetary Fund, told CNBC that major central banks will need to keep interest rates high for much longer than some investors expect.

“The market seems to be thus far handling a 5% risk-free rate without too much problem,” said John Luke Tyner, a portfolio manager at Alabama-based Aptus Capital Advisors, which manages $4.25 billion. “Without much degradation in employment, it’s likely you’ll continue to see inflation remain elevated. As long as people have money and jobs, inflation doesn’t really go away and shifts from one sector to another.”

Via phone, Tyner said that the stock market is “ignoring” any signs of persistent inflation and “looking for anything that’s not negative” to trade on. “It will probably continue to do that unless there’s a push in the narrative from the Fed that it needs to take rates drastically higher.” He also said, “I don’t see how you get inflation anywhere near 2% or less for the foreseeable future, at least on a sustained basis, barring a fairly large stumble in the economy.”

On Tuesday, all three major U.S. stock indexes


finished higher, led by a 1.7% advance in the Nasdaq Composite. Two-
through 30-year Treasury yields
also ended higher. Meanwhile, break-even rates, which reflect investors’ inflation expectations years into the future, traded around the 2% level.

Robert Daly, who manages $4.5 billion in assets as director of fixed income at Glenmede Investment Management in Philadelphia, said, “I’m a believer that inflation expectations are not meeting reality. While we could get toward 2% next year, I think it’s going to be a lot harder to get there because of the stickiness of inflation going forward.” 

Inflation levels of 3%-4% “may be a better estimate for a near-term landing spot, and the question is whether that’s good enough for the Fed,” Daly said via phone.

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