The U.S. Bureau of Labor Statistics’ Consumer Price Index (CPI), released Tuesday, has increased 8.5 percent over the last 12 months. Avantax Chief Investment Officer Ivan Gruhl says while inflation clearly is a key topic right now, softer-than-expected core inflation figures came as a welcome surprise for investors. Summary
March CPI – The facts: Inflation is clearly a key topic right now for investors. Data on Tuesday, April 12, from the Bureau of Labor Statistics showed the annual rate of inflation in the United States rising by 8.5% – a four-decade high. Most of the March increase was expected, driven by a jump in volatile everyday items such as gasoline and food prices. There was a silver lining, however, as core prices appeared to be moderating. Core CPI, which excludes food and energy prices, rose by 0.3% for the month, lower than the 0.5% gain investors were anticipating. Softer-than-expected core inflation figures came as a welcome surprise for investors, optimistic that March may be the peak for inflation as energy prices subside and year-over-year comparisons move lower. Federal Reserve – The Response: In anticipation of this higher inflation, the Federal Reserve began raising interest rates in March and is expected to continue doing so over the course of 2022 and into 2023. In recent weeks, the Fed has talked tough on inflation, and has outlined an aggressive path to more restrictive monetary policy. In addition to raising short-term rates, the Fed will reduce its balance sheet by $95 billion per month starting as soon as next month. That pace would double the peak pace of Quantitative Tightening from the prior cycle back in 2017-2019. Reducing the balance sheet primarily will involve the runoff and sale of longer-term Treasury bonds into the markets, which has put upward pressure on interest rates, with the goal of slowing economic growth and reducing inflation. While record inflation serves as a great eye-popping headline, the March inflation report was no surprise to Wall Street or the Federal Reserve. Current yield levels (April 12) for the 2-year and 10-year Treasuries are now 2.4% and 2.7% respectively. In our view, these rates already reflect anticipated rate hikes and balance-sheet reduction and offer higher yields and a good entry point into the bond markets. The Economic Challenge: Central banks around the world are now on course to tighten monetary policy amid excessive inflationary pressures. The ongoing war between Russia and Ukraine has added further inflationary pressures via increased commodities prices, supply-side bottlenecks, and geopolitical uncertainty. Since the onset of the COVID-19 pandemic, the U.S. economy has been artificially stimulated through borrowing money and distributing it through PPP loans and pandemic benefits. This re-inflating of the economy was essential and successful, albeit inflationary. For example, retail sales were up more than 25% between February 2020 and February 2022, with robust consumer spending adding to price pressures. As the economy has re-opened, generous pandemic unemployment benefits have ended and people are heading back to work. According to First Trust research, in the first three months of 2022, 1.7 million jobs have been filled. So, despite the fact the Fed will be raising rates, we believe the economy will expand in 2022 and profits should continue to rise. The Bottom Line: Despite the dual headwinds of inflation and higher rates, the economy remains on solid footing. Consumer balance sheets are still strong, incomes are robust, and the corporate sector is healthy. Admittedly, there are significant risks to the expansion. Still, in the absence of a significant escalation in the Russia-Ukraine conflict, we believe the underlying strength and resiliency of the U.S. and global economies can fuel a sustained expansion. Although the road ahead will be challenging, we think inflation will gradually subside, causing a mild cyclical downturn that rebalances the economy while avoiding recession. |
Inflation and Interest Rates: CPI at 40-Year High in March
