Timely and Relevant News: Inflation
Inflation has been on the rise. Everyone knows it and feels the impact with every purchase. The Consumer Price Index (CPI) spiked to 5.0% year over year in May, the most since 2008, while core CPI (excluding food energy) hit 3.8%, the highest since 1992. Inflation has been rising and the Fed is watching. How will markets react to any potential inflation over the next year?
Markets will be looking forward, not backward. Markets are no longer watching to see if inflation will spike. It already has. In fact, since the big upside surprise in the April inflation data, many inflation-sensitive assets have been underperforming. Copper? Down. Lumber? Down. The 10-year Treasury yield? Down. Market-implied inflation rates? Down. Gold? Down.
At the conclusion of its last policy meeting on June 16, the Fed shared its view on what may be coming for inflation. In its updated forecasts, the Fed acknowledged it had missed on inflation expectations, upgrading its preferred core inflation forecast for 2021 from 2.2% all the way up to 3.0%. The forecast for the same index in 2022 and 2023 scarcely moved at 2.1% for both years.
Inflation is certainly still capable of coming in hotter than expected. The difference between now and earlier this year is that inflation expectations are already elevated. We know there are areas where we’re seeing extreme price moves, which is impacting broader measures of inflation. What about prices that tend not to move? There is such a measure, developed by the Federal Reserve Bank of Atlanta, called sticky core inflation.
We’ll be watching both sticky core CPI and median CPI to help understand the pace of inflation. We do think inflation will continue to be transitory and elevated for the rest of 2021—and possibly into 2022—before it really starts settling down. A weaker dollar could also potentially have an influence on inflation.
If inflation does start to look more persistent and less transitory, it will certainly be felt on Main Street. For Wall Street, the immediate fear wouldn’t be the inflation itself, but rather its ability to force the Fed’s hand and accelerate policy tightening.
We continue to closely monitor the risks associated with the Fed acting out of concert with what markets are expecting. Over the next few weeks we’re likely to hear from a number of Fed officials, so we’ll get more clarity.
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