The Inflation Dog Didn’t Hunt in April

CPI Treemap: Area Represents Weight in Index, Color Represents % Change Year-Over-Year (Source: Payden&Rygel)

By:  Thomas Steffanci, PhD, Benefit Financial Services Group

The past two weeks saw some eye-popping inflation readings. The consumer price index (CPI) for April came in at 4.2% year-over-year (YoY), but a surprisingly large 0.8% month-over-month (MoM) gain. The producer price index (PPI) was also hot, coming in at 6.2% YoY and 0.6% MoM.1

The Federal Reserve has been telling anyone who would listen for the past several months that transitory inflation outbursts were to be expected, caused by pent-up demand, relaxed Covid restrictions, the stimulus, and temporary supply constraints. These would not move the Fed to begin to withdraw their liquidity provisions to the economy, as employment was still far below its pre-pandemic level.  Several Fed speakers went on record with saying as much…and again after the inflation reports.

But to listen to Wall Street, these numbers will pull the Fed forward in their timetable to begin to withdraw their support by reducing their purchases of Treasury and mortgage securities. For years, Wall Street has had an imbedded ‘recency bias’, meaning giving the most importance to the most recent event. So, you would have thought that market prices of stocks and bond yields would have reacted to the these “shocking” readings by reacting negatively as horns blew and whistles sounded.

Well, that is not what has happened. The futures markets for bonds and Treasury bills barely fluttered. More importantly, stocks and bonds in the cash market reacted positively since the May 12 inflation news. Ten- and 30-year bond rates have fallen 10 basis points since then. And the Nasdaq gained 4.8%, and the S&P 500 has risen by 3.4%.2,3

So why did this happen? As always, the devil was in the details which are frequently ignored by the headline grabbing talking heads. Goldman Sachs in a recent report went behind the numbers to ferret out the details. Here’s what they found:  90% of the CPI increase was accounted for by reopening price rebounds and supply disruptions. By far the largest contributor to the price rise in that category was used car purchases as new car sales were disrupted by parts shortages. The other large contributor was transportation services, chiefly airline ticket sales. All the other categories (core services) barely budged. And add to this that the year-to-year comparison period was March 2020 where prices actually fell, so you have a distorted picture of the importance of the April CPI.

What do we take away from all this? Two things. The market saw through the fog of the headline inflation numbers so don’t listen to the noise of the moment. And second, all this tells us is that the market…maybe…just maybe…is starting to believe the Fed when they say they will continue asset purchases for “some time” and that liftoff for the Fed Funds rate will not start until the second half of 2023. Of course, several like-sized increases like April’s during the next six months could move the needle closer. But not now.

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  2. The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market.
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