Stock Markets Give Up Early Gains as Investors Realize Inflation Will Be Tough to Beat

The stock market opened sharply higher on Thursday, but throughout the day, major market benchmarks gave up most of their gains. The S&P 500 (^GSPC 1.02%) finished the day just above the unchanged level, and neither the Nasdaq Composite (^IXIC 2.02%) nor the Dow Jones Industrial Average (^DJI 0.40%) managed more than a small rise.

Data source: Yahoo! Finance.

By all accounts, the Thursday morning release of the latest July Consumer Price Index (CPI) data went well. Yet even though the numbers from the Bureau of Labor Statistics look much more attractive than they did this time last year, investors nevertheless are starting to realize that the final push from the Federal Reserve to get inflation back down to its 2% target could take a lot of time and effort to achieve.

Where we stand with inflation

The headline numbers from the latest inflation report seemed to suggest that price pressures remain under control. The overall CPI climbed 0.2% in July compared to June's level. That was enough to push the 12-month change in the index slightly upward, to 3.2% from 3% the month before.

Measures of core inflation showed similar monthly gains, although the yearly increase remained more significant. The version of the CPI that excludes volatile food and energy prices was up 0.2% in July as well, bringing its year-over-year rise to 4.7%. Meanwhile, the 0.2% increase in food prices produced a 4.9% rise since July 2022, while a 0.1% rise in energy costs still left that measure down a whopping 12.5% over the past 12 months.

Shelter prices remained the biggest contributor to inflationary pressures, rising 0.4% for the month and 7.7% since this time last year. Offsetting those gains was a 1.3% drop in the price of used cars and trucks, and new vehicles also saw prices stay in check over the period.

Bond yields moved higher. The 10-year Treasury saw its yield jump a full tenth of a percentage point to 4.11%, while the 30-year climbed above 4.25%. Shorter-term Treasury debt saw more modest yield gains, but the two-year finished at 4.84%.

Image source: Getty Images.

Worries about energy

Year-over-year comparisons are set to get a little bit easier in the months to come. July 2022's CPI reading was flat compared to the previous month, but 2022 gains of 0.2% in August, 0.4% in September, and 0.5% in October give 2023's figures some room to come in below the year-earlier numbers. That would potentially bring the yearly CPI rise below the 3% mark. Inevitably, some would argue that any inflation figure with a 2 in it would be "close enough" for the Fed, even if it were 2.9%.

Yet there are good reasons for investors to prepare for persistent inflation. Energy prices have  climbed recently, with the average price for gasoline climbing to $3.94 per gallon, according to the Aug. 7 figures from the U.S. Energy Information Administration. Energy not only is a direct component of CPI but also plays a key role in determining retail prices for just about any good that needs to be transported in order to reach its end customers.

The rally in stocks in 2023 has hinged on the idea that inflation is under control. If that proves not to be the case, then it could lead to a sharp short-term reversal for markets. That's something that many investors don't seem prepared to see.