by Joe Herrle, CFA
Vice President, Alternative Assets
As those living in the Portland area are already well aware, we have been experiencing unseasonably cold and stormy weather this week. We have seen it all this week, with snow, sleet, hailstones, thunder, rain and even some sunshine scattered in between. With all of the inclement weather, our home took quite a beating. The 70-foot fir trees in our yard couldn’t handle the wet snow’s weight, and half of the branches came crashing down, completely covering the driveway with massive logs. Adding insult to injury, the storm resulted in a broken gutter, a damaged fence and a flooded lawn. I thought to myself, “when it rains, it pours.” Sometimes it seems unlucky events can and do cluster together.
The same might be said for recent market and economic events: stretched supply chains, higher prices at the pump, larger grocery bills, and this week, another hot inflation reading. However, if we take a closer look, the clouds appear to be shifting and a bit of sun might just be breaking through.
On Tuesday, inflation numbers came in hot across most components. According to the release of March inflation figures, consumer prices have risen by 8.5% over the past year and 1.24% month-over-month, a rate of increase not seen in more than 40 years. The surge in energy prices was the primary culprit in the high reading. Also, services prices rose by 0.6% over March, the biggest gain in 30 years. The silver lining to this cloud is that the services spike mainly reflected a temporary post-Omicron burst of reopening inflation. Also, gas prices have since moderated into April, and the price of consumer goods declined in March.
Source: Bloomberg
Another important aspect of this hot inflation number is that we are coming off the peak of the “base effect.” Base effects are important when looking at year-over-year inflation figures. Right now, we are reaching the end of the period in which we're comparing prices that were artificially depressed by the pandemic. Soon, we will be comparing prices that were hitting artificial highs thanks to global supply constraints. With this backdrop, we expect inflation readings to start moderating going forward.
There is, however, one small but dark cloud on the horizon: housing costs. “Rent equivalent” housing costs are a very sticky component of inflation … and have been rising. Housing costs rose 5% from last year and grew at a 0.5% monthly rate. Food, energy and used car prices can go up and down, but rental prices don’t tend to reverse once they rise. This is not yet cause for alarm but is something we will continue to monitor. So, while the overall inflation number may have peaked, the composition of inflation may be slightly more persistent than before.
When evaluating inflation, it is also important to consider the impact of interest rates and the Federal Reserve’s response. Due to recent comments by Fed officials and the high inflation reading, market participants are predicting a 50-basis point rate hike in May. However, the Fed does not increase rates based upon inflation readings, rather, rates are increased by the Fed in response to solid economic underpinnings that result in higher inflation. At this point, higher rates would be welcomed to help moderate rising prices and are an indication that the economy is strong enough to respond to them. Under the weight of inflation and higher rates, we believe the U.S. economy will prove much more resilient than the trees in my yard.
Week in Review and our Takeaways:
The U.S inflation rate rose to 8.5%, the highest since 1981. Meanwhile, the average savings account earns 0.06%, so we believe it is prudent to stay invested
Indications point to moderating inflation, and we may have experienced the peak in March
Earnings season kicks off during this shortened trading week, as the market is closed today for Good Friday