Is inflation peaking in Europe?

On the latest edition of Market Week in Review, Equity Portfolio Manager Olga Bezrokov and Associate Director of USI Investment Analysts, Chris Kyle, discussed the latest inflation numbers from Europe. They also unpacked the U.S. August consumer price index (CPI) report, and discussed the potential implications for markets and economies moving forward.

UK, French inflation rates slow

Kyle opened the conversation by noting that inflationary pressures eased in parts of Europe during August, with the UK consumer price index (CPI) climbing 9.9% on a year-over-year basis, while prices in France rose by 5.9% during the same time frame. Bezrokov said that in both instances, the gains marked a slowdown from July, when inflation advanced at a 10.1% clip in the UK and at a 6.1% rate in France, respectively.

"The August inflation report in the UK in particular was below market consensus for a very-high reading of 10.2%," she remarked, adding that the results from both countries suggest that inflation may have peaked in Europe. Despite this positive signal, however, Bezrokov said that indicators of economic sentiment in the region have turned extremely pessimistic - especially in Germany, where sentiment has approached all-time lows. The dour outlook can probably be chalked up to concerns around what persistently high European inflation - which has been exacerbated by the region’s energy crisis - might mean for the overall economy, she noted.

August CPI report triggers market selloff

Turning to the U.S., Kyle and Bezrokov homed in on the August CPI report, which led to a significant selloff in markets when it was released by the Labour Department on 13 September. Investors appeared to be particularly unnerved by a higher-than-expected increase in the core CPI, which strips out prices from the more-volatile energy and food sectors, Bezrokov explained.

"The rise in prices for services, including shelter, continued unabated during August, and actually surprised to the upside," she remarked, noting that the core CPI increased 0.6% during August, versus expectations for a 0.4% rise. Bezrokov said that 60% of categories in the CPI saw price increases last month, suggesting that U.S. inflation is both persistent and broad. Core producer-price index (PPI) data released the following day did little to alleviate concerns that inflation is becoming more entrenched in the economy, she added, with numbers surprising to the upside.

All in all, the recent reports helped unleash significant volatility in markets the week of 12 September, Bezrokov said, noting that this is common during times of tremendous uncertainty. "It’s important to realise that markets tend to be forward-looking, which means they’re pricing in not only what’s happening now, but also expectations for the future. And right now, there are a range of potential scenarios depicting how things could unfold as it pertains to both inflation and U.S. Federal Reserve (Fed) policy," Bezrokov explained, emphasising that each scenario has a decent probability of occurring.

Where are recession risks increasing the most?

Kyle and Bezrokov wrapped up the segment with a look at how the latest inflation numbers are likely to impact the Fed’s rate-hiking campaign. Bezrokov said the August CPI report suggests that the U.S. central bank is likely to continue on its path of aggressive interest-rate increases, with most traders pricing in a third-consecutive 75-basis-point increase at the upcoming 20-21 September, Fed meeting.

Bezrokov said that earlier in the summer, markets were factoring in the potential for a dovish Fed pivot - should there be a material hit to U.S. growth expectations - but with inflation continuing to run hot and potentially becoming more entrenched, they’ve recently returned to pricing in a more hawkish Fed policy.

"Importantly, a more aggressive U.S. central bank raises the chances of a Fed mistake - which in turn means that the probabilities of a recession in the U.S. are also rising," Bezrokov remarked. She emphasised, however, that the U.S. economy is on more solid footing compared to other parts of the world, such as Europe, where the ongoing impacts of the Russia-Ukraine war have heightened recessionary risks.

In addition, Bezrokov said that although the recent moves in markets have been dramatic, she and the team of Russell Investments strategists aren’t currently seeing strong signs of panic across all asset classes. She also noted that there hasn’t been a significant rise in default rates, and that overall, the repricing in markets is normal given the high degree of uncertainty.

"Ultimately, the key takeaway here is that in times of great uncertainty, having a thoughtful strategic asset allocation in place - and sticking to it, despite behavioral bias - is probably one of the most useful things an investor can do," Bezrokov concluded.

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Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.