There is a growing belief among economists and investors that inflation peaked in the third quarter of 2022. According to Bloomberg, worldwide inflation hit an annual increase of 9.8% and now has declined to around 9.5% as we head into the end of the year. There are hopes that inflation will drop to 5.3% a year from now, a figure that is still far above the Fed target but will indicate progress.
Fed Chairman Jerome Powell tacitly admitted the Fed is embracing the idea that inflation has peaked. The chances that the Fed will hike rates by 50 basis points rather than 75 basis points are around 80%, and the yield on the 10-year bond has dropped to 3.5%, which is its lowest level since Sept. 21.
The problem for the market is that a peak in inflation does not solve the many other economic issues facing the market. There are still concerns that inflation will stay sticky to the upside due mainly to wages, and there is the significant issue that the aggressive rate hikes are going to slow growth in the year ahead.
Here on Fridays morning the market will see the November jobs report, which should provide insight into the primary driver of inflation. Wages are not coming down and there is still strong labor demand in most areas of the market. There have been layoffs in technology, but job openings are still large and employers are not able to cut wages.
Peak inflation was the key issue for the market for many months, but now the concern is shifting to how fast inflation will continue to fall and to what degree the economy will cool. The Fed has made it clear that the fight against inflation is likely to continue for years, but the stock market is anxious to declare victory and start a new bull market. The market has suffered greatly every time it has become too optimistic in 2022.
There are a few things we need to watch today when the jobs report is released. If it is strong, will it cause concerns about inflation rising again? We will see if there is an impact on the odds of a 50-basis-point hike in a little less than two weeks. If the jobs numbers are weak, will the market celebrate that it indicates that inflation is coming down, or will it be concerned that it indicates the economy is slowing?
Peak inflation makes for a convenient bullish narrative, but it ignores a host of other issues that are going to prevent a quick return to a bull market.
Technically the indexes are in good shape for more upside as they digest the celebration of peak inflation and benefit from seasonality, poor positioning and short squeezes, but the news flow offers a high degree of risk.
The jobs news today will give us good insight into what the market is most worried about -- inflation or growth.
