Widespread Inflation Weighs on Consumers

The selloff that began last week in financial markets is continuing this morning as investors grapple with Friday morning’s CPI report and Consumer Sentiment report. The combination of inflation coming in much hotter than expected and consumer sentiment coming in at the lowest level on record triggered a selloff in bonds, stocks and crypto. At the heart of the selloff is the thought that in order for the Fed to get inflation under control they are going to have to be more aggressive in hiking interest rates than the market was previously pricing in.

Inflation

The May CPI report showed inflation rose by 8.6% year-over-year, the highest number in four decades. Consensus estimates by economic forecasters had been 8.3%. This has been the trend now for over a year. The combination of the Fed and Congress raining down trillions even after the economy was on the road to recovery in 2021 set off a rapid increase in inflation. Add in supply chain woes, Russia’s invasion of Ukraine and the recent lockdowns in China and you have everything you need for significant inflation.

Contributors to the 8.6% increase were widespread. Gasoline was up 48%, Airfares 37%, Used Vehicles 16%, Groceries 12% and Furniture 9%. Notice what is missing is the Shelter component. This came in at 5.5%. In reality home prices/rent are up greater than 15%.

Speaking of housing, last week mortgage demand dropped to the lowest level in over 22 years. Rates on a 30-year mortgage have leapt from 3% six months ago to nearly 6% today. We are finally seeing the beginning of a slowdown in housing that the Fed wants to see.

Take a look at the chart below. This shows the increase in money supply year-over-year going back to 1960. You can see the massive spike in 2020/2021. Going back to my earlier point, that is the result of the excess money from Congress and the Fed. Now here is where there is a glimmer of hope for inflation eventually coming down.

Consumer Sentiment

The second report of note on Friday was the University of Michigan Consumer Sentiment report. This number fell to 50.2, which was the lowest number on record. Consumers are clearly in a bad mood and inflation is the primary driver of this sentiment. The good news up until this point has been that consumers have continued to spend despite feeling pessimistic. We will be closely watching to see if this starts to change.

We have gotten more conservative as the year has gone on. First in mid-March and then in mid-May. Here is the good news- major losses in the bond market means much higher interest rates are available. This morning the 10-year Treasury is yielding 3.27%. This is the highest rate post-financial crisis. Many corporate bonds are yielding 5% plus. As we see rates stabilize we will begin deploying capital into select bond funds. As for stocks, selloffs like we have seen this year are the primary reason we hold extra cash and short-term bond funds. This allows us to take advantage of longer-term opportunities. This has been extremely profitable following past selloffs where we have seen many examples of the baby being thrown out with the bathwater. The bottom line is that future returns have gone higher as the result of this broad-based selloff, and while that is good news, we will continue to actively manage portfolio risk.