Markets Agitated by Inflation Data
Last week we saw the latest read on inflation with the Consumer Price Index coming in at 4.16% year-over-year, almost twice the consensus of economists. This was the highest reading in 13 years.
Another notable release was the University of Michigan’s Survey of Consumers, which measures inflation expectations for the next year. This jumped from 3.6% in April to 4.6% in May. The Wall Street Journal laid out the risk of higher inflation expectations:
The risk is that as inflation expectations rise, they become embedded in consumer behavior and business decisions. Workers demand higher wages to keep up with prices no matter the underlying productivity; businesses pay to keep those workers and then raise prices to compensate. Workers then demand high wages, as expectations are hard to break.
Everywhere consumers turn they are seeing higher prices. Gasoline, food, appliances and commodities have all been rising in price. Last month existing-home sales rose 17% over last year, the biggest jump on record. Here are some thoughts from Saturday’s Barron’s cover story:
“All you have to do is open up your eyes to see there is inflation pressure everywhere,” says Ed Yardeni, president of Yardeni Research. “We are in stimulus shock.” For evidence, he points to the 26% year-over-year increase in M2 money supply, the largest gain since 1943, as fiscal spending in response to the pandemic has topped $5 trillion. M1, or very liquid money in circulation, is up by 316%. The Fed, meanwhile, has shown no signs of slowing the $120 billion in monthly purchases of Treasuries and mortgage-backed securities that it began in response to the pandemic.
The Federal Reserve believes the pick-up in inflation is temporary, that many price increases are due to shortages and that once supply-chain issues are resolved price increases will moderate. But the Fed has been wrong before and some of their current actions are likely contributing to the inflation problem. As the Barron’s article points out, the Fed is still buying $120 billion of Treasury bonds and mortgage-backed securities. This policy was started last March when economic activity came to a halt. Fast forward until today and with economic activity booming it is outrageous that the Fed is still printing money at this pace. The purchase of mortgage-backed securities is a de-facto subsidizing of the housing market, which certainly needs no help from anyone.
The Fed isn’t alone in spending too much money. Congress has already spent trillions of dollars in 2021 with negotiations pending for more multi-trillion dollar bills. One example of unnecessary spending was the extension of Federal unemployment benefits through September. There is currently a labor shortage in almost every industry. In fact, last month saw 8.12 million job openings, the highest number on record. From CNBC:
The JOLTS report, combined with other recent indicators, show that “labor shortages are widespread, pushing up prices and potentially acting as a brake on the recovery,” wrote Michael Pearce, senior U.S. economist at Capital Economics.
In a recent note, Goldman Sachs economists noted that “labor supply appears to be tighter than the unemployment rate suggests, likely reflecting the impact of unusually generous unemployment benefits and lingering virus-related impediments to working.”
Market concerns over inflation have overshadowed what has been an outstanding earnings season. Company earnings from the first quarter have grown at over 50%, triple expectations from just four months ago. Over 87% of companies have exceeded analysts’ estimates. However, in the short-term expect inflation data to continue to take precedent over earnings reports in the minds of investors. Over the last few decades inflation has been tame, in large part due to advances in technology. The Fed believes that the current spike higher won’t last long, and will be followed by a return to the trend from the last 20 years. As always, we will keep you posted.