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Start of a Disinflationary Cycle?

Fed Chair Powell approved a more modest quarter-percentage point interest rate increase and signaled another rate hike next month to fight inflation. The Fed policy statement released after the FOMC meeting today suggests additional rate hikes will continue, maintaining the same monetary stance from the previous meetings.

The 0.25-point increase brings the benchmark federal funds rate to 4.5% and 4.75%, a level last reached in 2007, as the Fed continues to fight one of the highest inflation rates in the past 40 years.

Is the Fed nearing the end of its tightening process?

Consensus thinking believes the Fed will raise the fed-funds rate to 5% and 5.25% this year. The intended target would imply another two quarter-point increases in March and May FOMC meetings before a pause.

Is the worst behind, as far as interest-rate hikes?

Another two 0.25 percentage point increases will further slow down the rate of inflation. But this depends on how the economy reacts to the rate hikes in the next few months.

Ahead of the news conference after the FOMC meeting today, the view from the street is that Powell wanted to see more layoffs and a higher unemployment rate because this would confirm that interest rate hikes are cooling off a surging economy and keep inflation under control. The comments today from Powell did not suggest that this has occurred.

However, Powell pointed to a disinflationary process developing as job openings remain higher than expected. However, wage growth is subsiding, but many other economic indicators suggest the job market remains robust.

Unlike deflation, which is bearish on the economy over the long term, disinflation occurs when price inflation slows down, but it slows down temporarily. The slowing down of inflation is constructive to the economy longer-term, as this does not hurt the economy as badly as in a deflation cycle since the rate of inflation slows over a short-term timeframe. During deflation, lower consumer demand can lead to an increase in unemployment. A deflation cycle, if sustainable, can trigger an economic contraction and recession.

Disinflation is typically better than deflation or long-term inflation from the perspectives of financial markets and investors.


Deflation is when prices fall, and the inflation rate is negative (i.e., the Japanese economy during the 1980s-2000s). Disinflation occurs more often than deflation and is better for investors because the central bankers raising interest rates helps to reduce rising inflation in a relatively short period and in an orderly way. During disinflation, the inflation rate falls while the purchasing power climbs. The stock market fares poorly during deflation and hyperinflation cycles.

Unlike inflation and deflation, a disinflationary environment tends to be temporary. It also refers to the rate of change in the rate of inflation and not necessarily the direction of prices. Disinflation is not as bad for the financial markets and investors as a period of disinflation can prevent the economy from overheating. The caveat is when disinflation leads to the rate of inflation slipping to zero (i.e., during 2015), threatening to unleash a deflationary cycle.

Over the past couple of weeks, inflation has slowed because energy and other prices have fallen. Stocks have rallied because investors anticipate the Fed will begin to slow down its rate increases and engineer a soft landing.

Is the recent stock market rally sustainable?


Is it hope or reality?


Attached is a short-to-medium-term chart of the SPX Index. Oct 2022 to present rally is impressive, evidenced by the breakout above the Jan 2022 downtrend (4,035), 50-day ma (3,949.32), 200-day ma (3,952.64), and the 38.2% retracement (3,998.5).

Formidable initial resistance remains at 4,101-4,119 (Sept and Dec 2022 highs) and above 4,155-4,219 (50% retracement, 8/22/22 gap-down, and the Sept 2022 high), and 4,308-4,325 (May and Aug 2022 reaction highs and the 61.8% retracement). A convincing breakout above the summer 2022 reaction highs reaffirms the Oct 2022 low (3,491.58) as a pivotal bottom allowing for an intermediate-term SPX recovery toward 4,595-4,637 (Feb and Mar 2022 highs) and 4,818.62 (1/4/22 all-time high).

Initial support rises to 3,910-3,952.5 (Oct 2022 uptrend, 50-day ma, and 200-day ma). The convergence of the 50-day ma (3,949.32) and the 200-day ma (3,952.64) hints at a possible golden cross-buy signal. Violation of support warns at a decline to 3,764.5-3,810 (May and Dec 2022 lows) and below this 3,637-3,698 (Jun and Nov 2022 lows), and 3,584-3,491.58 (Sept and Oct 2022 reaction lows). Violation here will trigger the next sharp SPX selloff to 3,356 (bottom of the Jun/Oct 2022 downtrend channel).


Source: Chart courtesy of StockCharts.com

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