The Easy Part of the Fight Against Inflation Is Over

Stock markets moved higher on Wednesday, with the Nasdaq Composite (^IXIC 2.02%) leading the way higher with gains of more than 1%. The Dow Jones Industrial Average (^DJI 0.40%) and S&P 500 (^GSPC 1.02%) also ascended, albeit not as steeply, as investors were pleased with the latest macroeconomic news on Wall Street.

Data source: Yahoo! Finance.

Stocks were even higher coming out of the gate on Wednesday morning, following the release of Consumer Price Index data for the month of June. Yet even though most investors were quite pleased with the numbers and essentially seemed to think that inflation is no longer an issue, the sad reality is that the easy work in fighting price increases is now over. Yet inflation rates are still well above Federal Reserve targets, and it's far from clear whether even currently higher interest rates and tight monetary policy conditions will be enough to get over the finish line to defeat inflation once and for all.

Attractive headlines

It's easy to understand why some investors have been quick to declare victory over inflation. The broadest CPI measure climbed just 0.2% for the month of June, which was less than many economists had projected for the month. June's reading brought the year-over-year inflation rate to just 3%, which is the lowest for that measure in more than two years.

Even for those who discount CPI measures that include volatile components like food and energy, there was reasonably good news. The core CPI, which excludes food and energy prices, rose just 0.2% in June as well. That's the smallest monthly increase for the core reading since August 2021.

Image source: Getty Images.

A number of components of the CPI actually decreased for the month. These included airline fares, communication, used car and truck prices, and household furnishings. Drops in those categories helped to offset increases in shelter prices, as well as motor vehicle insurance, apparel, recreation, and personal care expenses.

Stock markets soared in response, and bond markets reacted with much lower expectations for future interest rate moves. Bond yields among intermediate maturities were down 0.14 to 0.16 percentage points, which is a relatively large move for the bond market. Shorter-term rates stayed relatively high, perhaps in recognition of the belief that the Federal Reserve is likely to keep tightening its grip on monetary policy until it's completely convinced that inflation will meet its 2% target.

A premature victory lap?

As optimistic as investors were, there are plenty of reasons to remain concerned about inflation. Even with the decline in monthly core inflation rates, the year-over-year rise there was still 4.8%. That's more than double the Fed target.

For those who prefer the broader CPI measure, it's important to recognize that the overall figure got a big push downward from a 16.7% plunge in energy prices over the past year. It's not out of the realm of possibility that prices for gasoline, heating oil, and other energy products could continue to fall, but it's more likely that energy will stop exerting so much downward pressure on overall CPI numbers from here on out.

Lastly, this was the final month in which year-ago CPI increases were extremely high. June 2022's 1.2% monthly rise was huge, and the fact that this month's figure took that out of the year-over-year calculation was the biggest component of the drop in annual inflation to 3%. Going forward, though, inflation won't get that kind of support, as July 2022's CPI was flat month over month, and August 2022's gain was just 0.2%.

Some stock analysts believe that a 3% inflation rate is low enough to warrant less extreme measures from central banks. If that proves to be the case, then it's possible that today's upward moves in stock markets will turn out to be justified. However, it's more likely that the Fed will remain vigilant in stamping out all signs of inflation, and that could mean that the move higher in stocks on Wednesday will turn out to have been a premature celebration.