- September is the worst month for S&P 500 seasonals and is also a month that tends to see unusually large declines
- Inflation expectations are far ahead of the current inflation statistics
- U.S. Aug CPI expected to strengthen
September is the worst month for S&P 500 seasonals and is also a month that tends to see unusually large declines — September is the worst month seasonally for the S&P 500 with an average monthly decline of -0.43% from 1950 through 2019. 
After September, however, the market then moves into the favorable 4-month seasonal stretch of October through January. Since 1950, the S&P 500 index has shown average monthly increases of +0.81% in October, +1.59% in November (the best month of the year), +1.48% in December, and +1.11% in January.
While the average monthly change in stock prices is important for considering seasonals, it is also important to note the months of the year when unusually large moves tend to happen. In that regard, we are currently in the middle of the time frame when the largest sell-offs tend to occur.
In the past six decades, there have been nine times when the S&P 500 has shown a monthly decline of more than 10%. Six of those nine plunges occurred during the dangerous period of August through November.
The worst months during the Aug-Nov stretch, with two declines of more than -10%, were September (in 1974 and 2002) and October (in 1987 and 2008). The two other bad months during the Aug-Nov time frame, with one decline of more than -10%, were in August (1998) and November (1973).
The February-March period is also a dangerous time-frame, with two declines in March of more than -10% (in 1980 and 2020), and one decline in February of more than -10% (in 2009).
Inflation expectations are far ahead of the current inflation statistics — There is currently a wide gulf between the PCE deflator, the Fed’s preferred inflation measure, and market expectations for inflation.
The PCE deflator in July was at only +1.0% y/y, which is half the Fed’s +2.0% inflation target and well below the +1.9% level that prevailed in January before the pandemic decimated the U.S. and global economies. The core PCE deflator in July was a little higher at +1.3% y/y, but still well below the Fed’s +2.0% inflation target.
By contrast, inflation expectations have moved sharply higher in recent months and are currently higher than before the pandemic. Inflation expectations can be measured by the 10-year breakeven inflation expectations rate, which is the difference between the yields on the regular 10-year T-note and the 10-year inflation-protected TIPS T-note.
The 10-year breakeven inflation expectations rate fell to an 11-year low of 0.47% in March, but has since rebounded sharply higher to the 1.75% area. That is actually higher than the average of 1.65% seen in Q4-2019 before the pandemic emerged.
The fact that inflation expectations are higher now than they were before the pandemic can be easily explained by the Fed’s extraordinarily easy monetary policy. The Fed not only has its funds rate target locked near zero indefinitely, but has also been pumping a huge amount of reserves into the financial system with its $120 billion per month QE program. The Fed has permanently injected $2.9 trillion of reserves into the financial system since February, bringing its balance sheet to a record high of $7.0 trillion.
In addition, Fed Chair Powell two weeks ago announced that the Fed, as part of its long-term structural monetary policy review, officially adopted a flexible average inflation target. That means that the Fed will now explicitly allow inflation to move above the 2.0% target for a period of time after inflation has been below 2%, so that inflation averages out near 2.0%.
Since the Fed adopted its 2.0% inflation target in 2012, the core PCE deflator has averaged only +1.6%, chronically undershooting the 2.0% inflation target. The Fed’s new policy aims to move that average up to 2.0% in coming years.
The question for the markets is whether the Fed will be successful in pushing inflation higher. The Bank of Japan has been trying to do the same thing for decades, without success. However, the U.S. has a more dynamic economy than Japan and the Fed has a better chance than the BOJ of driving inflation higher, if only because inflation in the U.S. is already substantially higher than in Japan. For that reason, the markets are likely to be correct that the inflation statistics will be moving higher in coming months and years.
U.S. Aug CPI expected to strengthen — The consensus is for today’s Aug CPI report to strengthen to +1.2% y/y from July’s +1.0%. Meanwhile, the Aug core CPI is expected to be unchanged from July’s +1.6%. 
The headline CPI fell to a 5-year low of +0.1% y/y in May due to the pandemic but then recovered to +1.0% by July, due in part to the recovery in oil and other commodity prices. Meanwhile, the core CPI fell to a 9-year low of +1.2% y/y in May-June before recovering to +1.6% in July.
The CPI statistics are likely to continue to strengthen in coming months as the U.S. economy recovers. Prior to the pandemic, the headline CPI in February was at +2.3% y/y and the core CPI was at +2.4% y/y.