What’s Going on With Inflation

Estimated reading time: 6 minutes

Another Day, Another Inflation Concern

The latest Consumer Price Index (CPI) was just released, and if anyone was hoping for some progress on the inflation front, this wasn’t it. Headline CPI rose 3.7% year-over-year, more than the estimate of 3.6%, and core CPI (minus food and energy) rose 2.6%, more than the estimate of 2.5%. 

In other words, it wasn’t just higher oil prices that put upward pressure on inflation. Even the metric that removes energy from the calculation came in higher than expected. 

Not surprisingly, Treasury yields initially rose in reaction. And by a lot. The assumption is this could force the Federal Reserve to hike interest rates more aggressively. After the report, the probability of a rate hike this month rose as high as 58% (from 22%), but as of Wednesday afternoon it stands at 35%.

The number of cross-currents in this market are growing by the day, and we don’t expect that to abate until at least after the midterm elections. In many ways, the market volatility tracks the historical patterns seen before midterm elections, which would suggest a relief rally afterward. While that’s entirely possible, nothing is guaranteed, and this cycle has included more surprises than we can count.

The Cost of Everything

We know that inflation affects consumers by raising the cost of everyday items like groceries and gasoline as well as more discretionary items like travel and apparel. The pinch of that is evident in the recent cratering of consumer sentiment surveys. To put it simply, consumers are feeling frustrated and discouraged. 

The thing is, consumer spending has told a different story. Again, to put it simply, consumers may feel bad, but their spending patterns haven’t changed much.

Ok, so people are still spending and businesses are still generating revenue as a result. Even though we can’t really pin down where people are getting the extra money to spend (since costs are going up faster than wages)… it’s coming from somewhere. 

Perhaps it’s coming from different places for different groups of consumers: Some are probably finding it in their stock market gains, some are using credit cards, some are pulling from savings, etc. 

In short, it’s a difficult question to answer with any broad generalizations, so I’ve stopped trying. 

What we can look at with some level of generalization is the rising cost of borrowing money. In any growing economy, businesses are apt to borrow more money to finance their growth. And this cycle is no different. 

The enthusiasm around AI has undoubtedly driven most of the growth in markets. Investors are anticipating incredible gains in productivity. 

However, companies in the AI ecosystem have started borrowing more to maintain competitive positions in the innovation race. Between this year and next, the hyperscalers are expected to increase their net debt levels more than seven-fold, and more increases are expected in 2028. 

As interest rates rise, the cost of servicing debt (making interest payments to investors) also rises. And we’ll need more demand (i.e. buyers) for all the corporate debt flooding into the market. If there are enough buyers to absorb that increased supply, we won’t have an issue. But I’m growing increasingly concerned that supply will outstrip demand, creating pain for the debt markets in 2027.

Hang In There, For Now

This inflation data dealt markets a tough blow, and unfortunately there’s no obvious solution to the problem. We’re also about three weeks out from midterm elections, which typically create a lot of uncertainty in markets. Plus, the war is still going on and yields are on an upward trajectory. That’s a lot for investors to grapple with, and stocks are feeling the pain. 

These periods can be very challenging to get through. We struggle with keeping my emotions in check just like any other investor. 

But we know that the only certain thing in markets (and life) is change — and we do believe things will change before the end of the year. Short-term headwinds continue to grow, but we believe they will peak on or around the midterms. Markets may not go straight up — and there are still likely to be weak spots — but some of the uncertainty will hopefully subside. 

Until then, hang in there.

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