Stocks and bonds took a beating on Friday after inflation numbers came in sizzling hot. Rate hike projections climbed as traders struggled to find any silver linings in Friday’s CPI report.
Where have you been? Come on, I know you didn’t need Friday’s CPI report to know that inflation is high and getting higher. I can’t blame you for hoping that the number would surprise on the downside, but if you are a realist …own a car, shop for groceries, eat at restaurants…or have any purchasing responsibilities really, you are well aware that stuff is just not getting cheaper. In case you missed it, Friday’s Consumer Price Index release showed that the CPI gained +8.6% year over year since last May, while economists were expecting an +8.3% change. What is worrying is not so much that economists got it wrong, as they often do, but rather that the number keeps growing. If we look past the headline number, the CPI Excluding Food and Energy, or Core CPI, we note that it grew at just +6.0%, only slightly higher than estimates and lower than last month’s annual number. The Fed typically focuses on core numbers due to the volatility of Food and Energy prices, but…come on, really? They may be volatile, but the reality is that we still must fuel up our cars and purchase food, so life for everyone is getting more costly. Specifically, Food costs rose by +1.4% last month while Unleaded Gasoline jumped by +4.6%.
Food and energy are necessities, and when they are costing more, consumers have less to spend on other non-essential items. Those item classes are where we witnessed the biggest price gains earlier in the pandemic, as supply chain problems and high demand caused prices of things like dishwashers, televisions, and home furnishings to jump. These categories have shown recent signs of price moderation while travel and services have been on the climb. Airfare alone gained +12.6% last month after gaining +18.6% and +10.7% in April and March. I suppose there is no sense in my sharing those specifics because you are most likely well aware. But what does this all mean for the markets?
Last Friday’s number appeared to surprise unsuspecting traders who began last week believing that the Fed would possibly stop hiking rates after June and July consecutive hikes. The CPI report certainly put an end to those hopes. Bond yields jumped in the response which, in turn, accelerated the selling in interest rate-sensitive stocks…um, almost all stocks. It is somewhat understandable considering that the CPI print was the highest in more than 4 decades. The bond market responded with 2-year Treasury Note yields jumping by some +25 basis points to 3.06%! For the record, we haven’t seen the 2-year at these levels since 2007. Those short maturity note yields attempt to determine where Fed Funds might be in 2 years, and not only are they higher than Fed Funds today, but also higher than the neutral 2.5% rate that Fed members like to refer to. Remember, yields higher than 2.5% are expected to slow the economy, while rates lower are still considered by economists to be accommodative to growth. So now what?
Inflation is getting somewhat more painful, and consumers are already shifting purchase habits to necessities. Will the Fed be forced to raise rates even faster than expected? Well, according to interest rate swaps and futures, the probability of more aggressive hikes through year-end have definitely gone up. More importantly, could all these interest rate hikes and rampant inflation cause a recession? They surely can, and the bond market is sending some clear signals on that. The yield curve between 2-year and 10-year Treasuries flattened in response to Friday’s number, and this morning WHILE YOU SLEPT, inverted briefly for a second time since early April. Inversions typically pre-date recession. I feel that I must refer back to hopeful signs some prices may moderate in coming months, specifically non-essential items. Big retailers have recently warned of rising inventories and price discounts to clear the bloat. So, yes that back-to-school sweater you may buy for your grandkid in late August may be cheaper, but unfortunately, there appears to be less of a chance that food and gasoline will be less costly. More unfortunately yet, higher borrowing costs related to Fed hiking are likely to have little or no effect on those prices…meaning more pain for consumers. Tomorrow, we will get Producer Price Index (PPI) numbers, and we will be able to gauge price pressures on producers. Wednesday, we will get Retail Sales figures from the U.S. Census Bureau, which will be another data point for the Fed, which will announce its policy decision later that day.
FRIDAY’S MARKETS
Stocks took a drubbing on Friday after CPI came in at a 4-decade high, hotter than economists were expecting. The S&P500 fell by -2.91%, the Dow Jones Industrial Average dropped by -2.73%, the Nasdaq Composite Index sold off by -3.52%, and the Russell 2000 Index gave up -2.73%. Bonds fell and 10-year Treasury Note yields jumped by +11 basis points to 3.15%. Cryptos fell by -5.75% and Bitcoin declined by -3.26%.
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