Last week’s Consumer Price Index print caught everyone by surprise – month-on-month pop of 0.9% core inflation (last time seen in 1982) was way above the consensus expectation of 0.3%. Whilst an increase in inflation has been discussed nonstop ever since the Fed announced their Average Inflation Targeting goal and the economy started showing signs of heating, such a jump caused markets to reverse to risk-off mode. The dollar jumped 67 basis points at the back of 10-year yield touching 1.70% intraday. Equity markets retreated with S&P500 sliding -2.14% and Nasdaq-100 shedding another -2.59%, both being already under pressure since Secretary Yellen comments about potential higher interest rates in the future.
The risk adverse sentiment improved as the day and week progressed. Potentially the investors took a pause and parsed the data, only to realize that most of the price increases were concentrated to the cyclical parts of the economy, but also to sectors that have been impacted by supply chain shortages. The largest contribution, almost one third, came from the increase in prices for used cars and trucks. The price increase of 10% can be attributed to the fact that the economy is re-opening and people are becoming increasingly mobile. Also, due to global semiconductor shortages that are mostly stemming from distortions in supply chains, there are less new cars available, forcing buyers (including car rental companies) to look at the secondary car market. Lastly, the public health situation has improved but probably not to the extent that everyone is comfortable taking public transportation. Therefore, the demand for used cars is likely to be above its long-term mean.
We can see a similar theme, looking at the other items that increased by a large margin. Event ticket prices grew by 10% – which makes sense as there are capacity restrictions, whilst the costs of running an event are either the same, or higher. Airline tickets went up 10% – again, seems reasonable due to increased demand after a long year of traveling nowhere. Airlines are operating with capacity restriction as well, whilst the costs are largely fixed. Lastly, hotel rates went up by around 5% which may be reasonable with the jump in demand we are witnessing for local travel in the U.S. These price increases are concentrated to less than 10% of the economy, whilst the major CPI contributors, such as shelter and medical services, did not move much.
Obviously drawing any conclusions from one month worth of data is rather pointless. Inflation is a condition that takes years to show its ugly face. Moreover, inflation is not an increase in CPI data but instead the rate of change, i.e., the second derivative or delta. CPI increases over consecutive periods matter, as well as whether the increases are progressively higher or not. What we may witness now is an increase in absolute price whereas inflation is a durable rate of change for a longer period of time.
FOMC meeting minutes published later this week may help to gauge the timeline for tapering of asset purchases. At this point the Fed is still buying around US$ 120 billion worth of bonds every month on the open market, providing the markets with ample USD liquidity. Should the purchases come to a halt as the economy is running red hot, we might see more pressure on risk assets, while the dollar is likely to gain from such a move.
S&P 500 slid -1.39% to 4173.90, while Nasdaq-100 shed -2.38% to 13393.12 points with increased inflation risk. Russell 2000, representing U.S. small and medium companies, shed -2.07%. The dollar index DXY was largely flat, gaining 0.08%, finding support near 90.15 level. Gold and oil futures rose respectively 0.64% and 0.72%.
Have a great trading week ahead!