Stocks and bonds rallied after the monthly consumer price index (CPI) was reported below expectations last week. According to the U.S. Labor Department, the index rose 8.5 percent in July, noticeably lower than the 9.1 percent rate reported in June. This deceleration may have convinced some investors that the inflationary wave has “peaked.” Others though may not be so sure. So where does the deal market stand?

The narrative is built on the notion that the U.S. Federal Reserve’s rate hikes have had the desired effect. If inflation continues to decelerate at this pace, the Fed may not need to raise interest rates as high as previously anticipated.

In fact, analysts such as Unicredit’s Erik Nielsen have even predicted that the Fed could start cutting interest rates as early as 2023. Such a pivot could potentially revive asset valuations. However, private equity investors are cautious about these macroeconomic signals.

“Last Spring, we saw similar calls for peak inflation that proved to be illusory,” says Alison Adams, executive vice president and research consultant at Meketa Investment Group. She explains that the latest CPI may have been lower than the previous month but it was still significantly higher than the Fed’s target rate of 2 percent. Underlying factors such as food prices and rent could be relatively “sticky” and keep the rate elevated for longer.

Historical evidence seems to justify this cautious approach. Inflation declined several times during the 1970s, only to bounce back higher in subsequent years. Core CPI dropped from 6.3 percent in 1970 to 3 percent in 1972 before surging to 9.1 percent in 1975 and 12.4 percent in 1980. This is why a single month of better-than-expected data needs to be taken in context.

“Like the Fed, we remain very much data-dependent,” says Adams. “Inflation is not the only headwind that we are monitoring. Consumer sentiment indicators are quite poor and real wages are lagging inflation.”

The inversion of the yield curve was another element on the Meketa team’s radar. Today’s 1-Year Treasury stands at 3.3% while the 10-Year is just 2.9%. If this inversion persists while the unemployment rate climbs, it could indicate that the economic slowdown is becoming a bigger concern than inflation. “At some point, the Fed will have to switch from inflation fighter to growth defender,” Adams says.

This sentiment was echoed by James Andersen, managing partner and co-founder of Clearview Capital. “I expect the Fed will slow its pace of interest rate increases. They really don’t want to send the economy into recession,” he says.

With Private Equity sitting on $1.8 trillion in cash commitments, according to Preqin data, there’s a lot riding on which way the Fed decides to go, and its outcome.

-Vishesh Raisinghani