by Blaine Dickason
Senior Vice President, Trading and Fixed Income Portfolio Management
Both the financial and popular press have been inundated with headlines on inflation. Last week’s higher than expected Consumer Price Index (CPI) report added fuel to this fire. Given the elevated inflation measures reported the last two months, two questions rise to the fore: 1) Is the inflation we are all seeing temporary or long-lasting, and 2) How and over what timeframe will the Federal Reserve address it.
Inflation affects all participants in the economy, whether you are a business owner, consumer, lender or borrower. Expectations for price increases in the future have a significant influence on economic activity today. Long-lasting or persistent inflation requires more than just a temporary imbalance between supply and demand. Expectations for a faster pace of price increases would need to become entrenched in the respective economic decisions of both buyers and sellers to metastasize into a structural and persistent problem.
Price action in commodities and Treasury yields since the April CPI report suggest the market is not expecting markedly higher interest rates. Other market-based measures of inflation, derived by real money buyers and sellers, have withdrawn from peaks seen immediately after the recent elevated CPI data. The May U.S. Services Purchasing Manager Index was released this morning at a record-high level, confirming that the services sector is rapidly improving after lagging the manufacturing sector through earlier COVID lockdowns. Even with this historically strong report, U.S. Treasury yields were flat on the day, demonstrating a level of comfort that our strong economic rebound will not lead to runaway inflation.
The month of September may prove to be another inflection point in the current economic recovery. In addition to schools planning to reopen on a full-time basis, this is also the month that the augmented unemployment benefits are set to expire. After the recent April jobs report disappointment, there was concern that even with 6.1 percent unemployment and 8 million fewer jobs than February 2020, there was a shortage of available and willing workers. As the hurdles and disincentives to return to work drop away, and vaccination rates improve, we are likely to have a much clearer picture on the labor market this fall.
We have highlighted that the next move by the Federal Reserve would likely be to begin communicating their plan for winding down the significant monetary stimulus they are providing the economy. This currently consists of near-zero interest rates and $120 billion per month of asset purchases. Chair Jerome Powell has famously said they are not even thinking about thinking about raising rates until significant progress has been made toward their employment targets. Based on the minutes released this week from their most recent meeting however, some members of the Federal Reserve are thinking about thinking about reducing the scale of their asset purchases. For those skeptical the Fed would take action to stem inflation pressures, it was on net a hawkish indication that they remain diligent and committed to their Congressional mandate to maintain price stability throughout this new economic expansion.
Week in Review and Our Takeaways:
The S&P 500 declined 0.39 percent for the week
Housing starts for April 2021 versus the prior month showed a decline of 9.5 percent as both land and labor constraints limited total activity