Inflation moderates while Fed continues hawkish tone

CPI data shows signs of inflation slowing

Much anticipated CPI data released last week came in somewhat below expectations, marking a softening from recent record-setting data prints. Headline year-over-year CPI increased 8.5%, relative to last month’s 9.1% showing, while the month-over-month increase was zero, which follows multiple months of high readings. While those headlines mark an improvement, energy was an outsized contributor last month, representing lower fuel and power prices. As evidenced in the chart below, prices for food and services showed little-to-no moderation in price increases.

As such, core year-over-year inflation in July repeated the prior month's figure of 5.9%. Core month-over-month inflation increased 0.3%. As the market interprets the impact of Federal Reserve policy on the data, conclusions are mixed: on the one hand, rate hikes seem to have had some impact on inflation moderation; on the other hand, July could be viewed as an aberration with lower data the result of declining energy prices.

Fed tone unchanged in the face of inflation data

Multiple Fed presidents who spoke last week reaffirmed the Fed’s commitment to battling inflation, resulting in the market seeing a hawkish Fed. Minneapolis Fed president Kashkari noted the Fed is “far from declaring victory on inflation” and that the recent data does not change its forecast of rate hikes. Richmond Fed president Barkin urged his fellow committee members to keep raising rates to bring inflation to the Fed’s 2 percent target. San Francisco Fed president Daly also reaffirmed the Fed is nowhere near its price stability goal, setting the stage for a 50 basis points hike in September.

Market pivots to risk-on following inflation data

Despite the Fed’s hawkish tone, markets reacted positively following the CPI print, with the S&P 500 reaching its highest level since April. In rates markets, the story is more nuanced. The existing spread between the 2- and 10-year Treasuries was exacerbated this week, with the 10-year roughly 40 bps below its 2-year counterpart. Accordingly, expectations for rate hikes in the short-term have either remained or increased slightly, while the longer-term rate outlook has seen downward movement.

Companies looking to swap floating rate debt to fixed are increasingly assessing the optimal hedge structure. Given the inverted curve, many companies are seeing an opportunity to lock in a lower rate by forward starting an interest rate swap at the point beyond the curve inversion (i.e. in mid-2023 or beyond). For companies looking to extend existing hedges, a similar opportunity exists.

Crude oil remains under $100/bbl

Brent-Crude futures fell to their lowest level since February on Monday after China reported slowing economic growth and Saudi Arabia’s Aramco announced it would expand output by 1 million barrels per day by 2027. Importantly, the spread between crude oil and refined products — commonly known as the “crack spread” — has continued to trend downward; the spread between heating oil and crude is currently around $50/bbl, after peaking near $80/bbl in June. Historically this spread is around $20/bbl, so the decline represents a moderating but not a return to historically normal spreads in these markets.