The October consumer price index (CPI) in the US was softer than expected. The overall index rose 0.4% (vs. estimate of +0.6%), despite a 1.8% increase in energy prices and a 0.6% increase in food prices.

But even more important was the downward surprise in core inflation which rose by only 0.3% (versus an estimate of +0.5%) and with the year-on-year rate declining by three tenths to 6.3%. Services inflation in particular also slowed more than expected, with housing categories rising at their slowest pace since May and moderation in some wage-sensitive service categories, including hospital services, childcare and personal care.

Core prices were particularly weak, falling 0.4% in October, and it appears that some of the factors driving inflation over the past year have begun to ease or reverse.prices, down 0.4% in October, and it appears that some of the factors that drove inflation over the past year have begun to slow or reverse. Two areas that are particularly notable are vehicle prices and health care prices. It is likely that the increased supply of vehicles has helped alleviate price-related pressures of late, and the CPI for new and used vehicles declined by 0.9% in October after an average monthly increase of 0.8% over the previous twelve months.

Overall CPI 7.7%, down from 8.2% in September and the "lowest" level since January. Core CPI also slowed at the margin.

Weaker core inflation is good news for the Fed. Policymakers have indicated that their preferred next step would be to reduce the pace of rate hikes to 50 basis points at the December FOMC. Indeed, futures markets expect 50-25-25 basis points for the next three meetings. So, the market believes there is about 100 basis points to go before the Fed ends the tightening cycle with a terminal rate around 5%.

The rate market has lowered expectations for the terminal rate to just under 5%. Inflation expectations recede

Market Scope

• By the way, the market reaction to the "more positive" news on inflation has been well received and will revive trading based on a "policy pivot". Market rates have responded with a 25 basis point drop and the 10-year treasury rate is back under 4%, this is good news for fixed income investments at the margin, although for the time being we continue to prefer a more conservative strategy in terms of credit risk and duration.
• For equities, lower interest rates mean less pressure on valuations at a time when corporate visibility was somewhat questioned after 3Q22 results, with further downward revisions in expected earnings for 2023. In this regard, while the recovery is likely to be stronger in the most interest-rate sensitive segments; Nasdaq - technology - consumer discretionary; we continue to prefer a more value strategy from a fundamental perspective.
• We maintain our estimates of fair value levels for the S&P 500 at around 4,000 points.

Lower interest rates mean less pressure on valuations at a time when expected earnings have begun to correct further downward

S&P 500 year-end 2022 forecast based on 2023 estimated earnings per share, 10-year Treasury yield; yield gap of 2.5%.

Humberto Mora

Assistant Investment Manager Finance and Business Finance and Business Brokerage Firm