The consumer price index (CPI) for October in the US was lower than expected. The overall index rose 0.4% (vs. an 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 only 0.3% (versus an estimate of +0.5%) and with the year-on-year rate falling three tenths to 6.3%. In particular, services inflation also slowed more than expected, with housing categories rising at their slowest pace since May and moderation in some wage-sensitive services categories, including hospital services, daycare, and personal care. 

Commodity prices were particularly weak, falling 0.4% in October, and it appears that some of the factors that drove inflation over the past year have begun to ease or reverse. Two areas that are particularly notable are vehicle prices and healthcare service prices. Increased vehicle supply has likely helped ease price pressures lately, 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 slows marginally.

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

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

Market reach

• Incidentally, the market reaction to the "more positive" news on inflation has been well received and will reactivate trading based on a "policy pivot." Market rates have responded with a 25 basis point drop and the 10-year Treasury rate is back below 4%, which is good news for fixed income investments on 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 has been somewhat questioned after the Q3 2022 results, with greater downward revisions in expected earnings for 2023. In this regard, although the recovery is likely to be greater in the segments most sensitive to interest rates (Nasdaq, technology, and consumer discretionary), we continue to prefer a more value-oriented strategy from a fundamental perspective.
• We maintain our fair value estimates 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 forecast for the end of 2022 based on estimated earnings per share for 2023, 10-year Treasury yield; yield gap of 2.5%

Humberto Mora

Gerente de Inversiones Finanzas y Negocios Corredora de Bolsa