Friday's Market Minute: Wall Street's Inflation Obsession

This week, U.S. Consumer price inflation for the month of April came in much stronger than expected. Both the headline and core CPI exceeded expectations, triggering a sharp sell-off in equities mid-week. Inflation fears have been stalking the market all month and are showing few signs of easing. Wall Street cannot get inflation out of its head, and the data confirmed investors’ fears of overheating and prompted bets that the Fed could move on rates earlier. While some inflation is good for companies and the market, the latest price data points to the balance moving too far in one direction, creating a potential drag on consumer purchasing power, higher input costs, and lower corporate profits. The debate for many is over, undoubtedly convinced inflation will not be transitory. Corporate America will clearly be passing along the recent commodity cycle-driven price increases onto the consumer.

Producer prices often lead to higher consumer prices, so yesterday’s hot print should have provided another move higher in Treasury yields, but it did not. U.S. stocks recovered because, despite inflationary fears, equities are still attractive relative to less risky lower-yielding fixed-income securities. The S&P 500 bounced off the 50-day moving average after a three-day slide knocked it down a respectable 5% from recent record highs.

Despite inflation rising 4.2% year-over-year, Fed speakers have been keen to emphasize that they still only see this rise in inflation as temporary. Fed officials will not budge from their ultra-accommodative stance anytime soon, and even several more months of hot inflation readings will not be enough to have them change their belief that this spike in prices will pass. While inflation has jumped recently, inflation expectations do not seem to be climbing much as indicated by long-term interest rates below year-to-date highs. When comparisons are made against depressed service-sector prices recorded last spring, it is no surprise to see such a robust year-over-year rate of change. Transitory supply bottlenecks and labor shortages truly exist, but the Fed’s full employment mandate is still a long way off.

Volatility is part of the program, which clears a path for quick-witted opportunist investors, but perhaps the equity market should take calm cues from the bond market, which was clearly unphased by the higher-than-anticipated inflation prints.

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