We think the head-turning inflation reading, even though backward-looking, is enough to justify a hike of at least 0.75%. Rate hikes are being pulled forward - In response to last week’s data, as well as the Bank of Canada’s unexpected 1% policy rate hike, markets started pricing in a greater likelihood that the Fed would announce a supersized rate hike at its July meeting.This will force the bank to keep its foot firmly on the brakes as growth weakens. Even if June marks the peak for this cycle, as we expect, inflation is unlikely to return to the Fed’s 2% target anytime soon. Central banks are caught between a rock and a hard place - With the June CPI marking another sizable inflation increase, the Fed is under pressure to continue its outsized rate hikes.Markets look past the inflation hump and focus on slower growth ahead. The graph shows the price of wheat futures which have recently erased their 2022 rally triggered by the war in Ukraine. Shelter inflation is likely to stay high for the rest of the year, and a tight labor market continues to support strong wage growth. For example, lower commodity prices will depend on easing geopolitical tensions. However, this moderation will likely be slow. Expect pressures to moderate slowly - We think inflation will moderate in the coming months, helped by lower commodity prices, more favorable comparisons, easing supply shortages, lower demand for goods as consumption shifts toward services, and an overall slowdown in economic growth.But historically, a slowdown in home prices takes about a year before it’s reflected in rents. With borrowing costs rising sharply, the housing market is starting to cool. Two-thirds of the CPI components are rising more than 5%, and rent - the biggest services component - recorded its largest monthly advance since 1986 1. However, price pressures still remain broad. This is the third straight month core inflation has cooled from its high of 6.5% in March 1. Yet inflation is too broad for comfort - The core CPI index - which better reflects the underlying inflation trend because it excludes the more volatile food and energy prices - rose at a 5.9% pace over the past year, down slightly from the 6.0% pace reported for the past month.For example, oil is down 22% from its peak, natural gas is down 28%, copper is down 34%, lumber is down 62%, and wheat is down 44% 1. While commodity prices remain elevated, we have recently seen broad-based weakness, supporting hopes that inflation is peaking. Gasoline prices, a major contributor to inflation, were over $5 a gallon in mid-June but have since fallen to a national average of $4.58. But since June, commodity prices have fallen sharply - Oil declined last week to its lowest level since the start of the Ukraine invasion, briefly trading at $91 before ending the week at around $98.Adding to the pressures, food prices had their highest monthly increase since 1981 1. Energy prices alone were 42% higher from a year ago and rose 7.5% from May, contributing to almost half the overall increase in inflation. High energy and food prices are driving the story - Headline CPI increased 9.1% from a year ago, up from 8.6% in May and ahead of consensus expectations.InflationĪnother upside surprise triggers volatility, but some relief is on the way.
We’d offer the following perspective on inflation and the yield curve inversion, and share our views on the investment implications. After this past Wednesday’s inflation news, the S&P 500 rose while the 10-year Treasury yield fell, indicating markets might already be looking past the inflation peak to the likelihood for slower economic growth ahead. While markets finished lower for the week, June’s inflation surprise elicited a different market response from May’s consumer price index (CPI) surprise.
This suggests the Federal Reserve has more work to do to achieve its price stability mandate. June’s stronger-than-expected rise in consumer prices pushed headline inflation to 9.1%, a 41-year high1.
Inflation and central bank policy were in the driver’s seat last week. Inflation, Inversion and Investment Implications