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Volume 10, Edition 17 | May 10 – May 14, 2021

Inflation Concerns Overdone

Doug Walters, CFA
A surprising inflation report had the stock market on edge this week, but the reaction proved overdone with the Fed having the last word.

Contributed by Doug Walters, Max Berkovich

Inflation fears were top of mind for investors this week, sending stocks lower. It is amazing how quickly we have gone from concerns of a deflationary spiral to runaway inflation. This week’s instigator was a surprising Consumer Price Index (CPI) report that showed higher-than-expected year-on-year growth. The Federal Reserve played the role of placater, which appears to have paid off as the week progressed.

It was not too long ago economists were concerned that, with rates so low, the Fed had run out of tools to boost the economy and that the U.S. could be following the path of Japan. The land of the rising sun has been battling deflationary pressures for the better part of two decades. Suddenly, concerns have turned 180 degrees toward inflation. Why does inflation matter? Currently, the Fed is boosting the economy with low-interest rates and asset purchases (aka quantitative easing). Should inflation begin to run too hot, the Fed’s hand will be forced into tapering its stimulus sooner than expected. “Taper” is a dirty word for stock investors, as equity prices have historically pulled back as the Fed scales back its monetary support.

The CPI reading this week was much higher than expected, sending the market down. Interpretation is a challenge, though, thanks to two factors: 1) prices were depressed last year due to the pandemic, and 2) demand for goods and services, as reopening accelerates, is bouncing back more quickly than companies can supply. Supply chains take time to rebuild, and companies likely took a cautious approach. The Federal Reserve was out in force this week saying as much. They are sticking to their claim that this bout of inflation is transient and should not concern the U.S. economy. The stock market rewarded their persistence with a bounce Thursday and Friday.

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4.2%

Inflation was much higher than anticipated

Inflation, as measured by the Consumer Price Index (CPI), came in much higher than expected. The reading comes at a time when investors fear that inflation may force the Fed’s hand into a soon-than-expected reduction in stimulus.

Headlines This Week

Path to Normality

  • The Centers for Disease Control and Prevention (CDC) stated that fully vaccinated individuals do not need to mask in most settings (unless required by an establishment). Following the CDC update, at least eight states lifted mask mandates.
  • The U.S. COVID-19 infection rate continues to fall amid successful vaccine rollouts. Teachers’ unions are calling for reopening all schools this fall.
  • Due to the measured success of the vaccine, the pandemic may experience exponential decay and ultimately meet its end (according to the Washington Post).
  • The Food and Drug Administration (FDA) approved Pfizer’s BioNTech COVID-19 vaccine for ages 12-15. It is the first and only FDA-approved vaccine for children in this age group.

Keeping Up with Inflation

  • The Consumer Price Index (a measure of inflation) was up 4.2% this April vs. the same month last year. This is an artificially high number because prices were depressed by the pandemic last year.
  • Some economists argue that higher prices in commodities and rising prices from producers will cause inflation to overshoot the Fed’s average inflation target rate of 2%. Market participants fear that our Central Bank will be forced to taper more quickly than the market anticipates.
  • However, Federal Reserve governor, Christopher Waller, stated that the Fed should not move too quickly in chasing inflationary ghosts.
  • Separately, job openings, measured by the Job Openings and Labor Turnover Survey (JOLTS), are at a 10-year high. This is a very positive sign for the labor market but could signal wage inflation ahead.

Making Records

  • Earnings season is winding down. Over 91% of the companies in the S&P 500 index have reported their earnings.
  • S&P 500 earnings grew by about 49% in the first quarter vs. the same period a year ago, marking the fastest earnings growth since 2010.
  • The largest contributors to the earnings growth came from the Financials sector, followed by Technology, Communications, and Consumer Discretionary.

The Week Ahead

The Republican Counter-offer

The GOP’s revised infrastructure offer is expected as early as next week after 10 of the party’s lawmakers met with President Biden last Thursday.

  • The main sticking points between the parties are what qualifies as infrastructure and how to pay for it.
  • Last month Republicans came back with a $569 billion bill, much smaller than Biden’s $2.3 trillion plan.
  • The GOP plan is likely to exclude things that the Democrats have included as “human infrastructure,” such as child and home care.

European Check-in

Several critical data points are due from Europe next week, including Q1 GDP, Consumer Price Index (CPI), and Markit PMIs.

  • Q1 GDP for the Eurozone will be out next Tuesday and is expected to still be in negative territory after much of the region was in lockdown for the quarter.
  • The headline for the area will most likely be the preliminary PMIs for May after rapid vaccinations have allowed several countries to reopen, causing the European economy to show signs of life.
  • While America’s inflation has seen a recent surge, the Eurozone is due to report a more stable 0.8% year-over-year growth when CPI data is released next Wednesday.
  • This differing economic outcome is primarily due to the area lagging behind the US in the pandemic recovery cycle.

FOMC Meeting Minutes

The minutes of the Federal Open Market Committee (FOMC) are set for release next Wednesday.

  • The report was from the meeting three weeks ago; therefore, most of the sentiment is priced-in and will largely be viewed as out-of-date by the market.
  • With a disappointing jobs reports and inflation far exceeding predictions, the outlook from when the meeting took place has shifted quite dramatically.

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