Markets are making a bet that inflation is finally starting to ease

Published Wed, Jun 7 20233:00 PM EDTUpdated Wed, Jun 7 20235:29 PM EDT

Skittish investors looking for a reason to buy stocks have been taking some solace from indications that inflation is heading lower. Disinflationary trends could take some of the heat off the Federal Reserve, which is widely expected to hold the line on interest rates at its meeting next week. While inflation remains well above the central bank's stated 2% target, there is some evidence that the trend is headed in the right direction. There is "good news for both inflation and growth," Evercore ISI Chair Ed Hyman said in a client note Tuesday. Hyman cited multiple factors for his belief that price pressures are easing. The note comes as markets staged a strong May rally that continued into early June. The S & P 500 is up 2.4% over the past five trading days. Last week was the best for the large-cap index since March. For one, Hyman noted that the labor force participation rate for the prime age group — 25 to 54 years old — stood at 83.4% in May. That number has been climbing steadily since bottoming at 79.9% in April 2020, and was nearly a full percentage point lower than the May figure in 2022. More workers heading back to the labor force could in turn take pressure off wages, which have been both a contribution and a result of the inflation surge of the past two years. Job-search site Indeed reported Wednesday that wages rose 5.3% on an annual basis in May, down 0.4 percentage point from April and well below the 9.3% peak in January 2022. More signs of declines Hyman also noted that shelter prices could be headed lower as the pace of rent increases slows, citing RealPage data showing rents up 2.3% year over year in May compared to their March 2022 peak of 15.6%. Fed officials already had been largely discounting shelter prices that they expect to recede through the year. Policymakers are more focused on what has become known as "super-core" inflation, which counts services excluding food, energy and shelter costs. Hyman said there's good news on that front as well. S & P's services PMI release showed that prices paid for services in May, while elevated, rose at their second-slowest monthly pace since October 2020. Core services inflation "is likely to slow significantly for the rest of this year and next," Hyman wrote. To be sure, inflation is likely to remain a problem ahead, and Fed officials have said multiple times that the current level is too high . 'An important reminder' for the market "I do not support stopping rate hikes unless we get clear evidence that inflation is moving down towards our 2% objective," Fed Governor Christopher Waller said in a speech a few weeks ago. "But whether we should hike or skip at the June meeting will depend on how the data come in over the next three weeks." Markets are pricing in a 71% probability that the Fed will skip the June meeting — but a nearly 70% chance that officials will hike again in July. The Fed's global counterparts also are still worried about inflation. The Reserve Bank of Australia surprised markets Tuesday with a 0.25 percentage point hike, and the Bank of Canada followed with that same size increase on Wednesday , taking its benchmark rate to the highest level in 22 years. Both moves "should also be an important reminder to markets and Fed officials," Citigroup economist Andrew Hollenhorst wrote Wednesday. "As soon as it becomes clear that rates need to rise more, the logical course of action is to raise rates." Fed officials will get one more look at inflation data before the June 13-14 meeting when the consumer price index for May is reported on Tuesday, which should provide clues about where things are heading. Treasury Secretary Janet Yellen , a former Fed chair herself, said she thinks inflation will show continued signs of easing. "I see a path to bringing down inflation while maintaining a strong labor market," Yellen said Wednesday on CNBC's " Squawk Box ." "I think the data we've seen recently and over the last year suggests we're on a path with those characteristics."