Inflationary Pressures on the Rise, But Could Still Prove Temporary

As we’ve suggested for the past few months, prices are increasing in several areas of the economy, and the data last week showed that impact has now reached the U.S. consumer. To use the Fed’s own language, the inflationary pressures are expected to be transitory — or decrease over time as the initial wave of the economic recovery subsides.

Time will ultimately tell how quickly and for how long prices can rise, but we maintain it is a key concern that investors should continue to monitor into the second half of the year. Some potential ways to hedge against this impact are by owning commodities or treasury inflation-protected securities (TIPS).

It bears repeating that a major driver behind rising prices is that the U.S. economy is performing well by several measures. An initial recovery in the manufacturing sector last summer has been followed by a release of pent-up demand for services. That’s showing up in data like restaurant visits, where OpenTable recently said Mother’s Day reservations this year were up 64 percent from a pre-pandemic environment in 2019.

We believe it’s possible to be optimistic about the direction of the U.S. economy and the overall investment landscape while still noting that inflation questions may linger. In the meantime, we expect little or no change in the accommodative monetary policies of the Federal Reserve until there is a more pronounced jobs recovery.

WALL STREET WRAP

Consumer and Producer Prices Top Expectations: On Wednesday, the Bureau of Labor Statistics said that the consumer price index (CPI) increased 0.8 percent month-over-month in April, exceeding market expectations. Excluding food and energy costs, the core rate grew by 0.9 percent. Compared to a year ago, the headline CPI increased 4.2 percent, and the core rate grew by 3 percent. These large annual numbers are due in part to the base effect, reflecting the depressed state of the economy last April, when we were first coping with a nationwide shutdown because of COVID-19. Looking at what areas drove the price gains in April, 10 percent increases in used cars/trucks and airline fares should likely prove temporary.

The producer price index (PPI) on Thursday also demonstrated sharp year-over-year increases. Headline prices rose by 6.2 percent in April, or 4.1 percent excluding food and energy. The key for all of these readings will be in how long the inflationary pressures persist. If driven primarily by restarting the global economy from a near standstill that resulted in supply disruptions, we, too, would expect prices to subside over time.

Retail Sales Level Off, But Still High: The Census Bureau reported on Friday that seasonally adjusted U.S. retail sales were unchanged in April from an upwardly revised result a month ago. Excluding autos, sales were down 0.8 percent month-over-month. Auto sales and restaurants/bars saw the largest growth in April, while receipts at clothing and general merchandise stores declined. Despite the benign report, it’s worth noting that without seasonal adjustments, retail sales are up 22 percent from April 2019. That comparison to a pre-pandemic era is a reminder of just how strong retail spending currently is.

NFIB Small-Business Optimism Rising: On Tuesday, the National Federation of Independent Business said that its small-business optimism index increased to 99.8 in April. That marked the highest reading in five months, as 8 of 10 components in the survey increased. Low inventory readings suggest that production can continue to grow to meet customer demand.

Below the headline number, the report also showed that small businesses continue to face inflationary pressures. A record 44 percent of those surveyed said they could not fill job openings, which led to 31 percent of firms increasing wages. In addition, the net number of small businesses increasing selling prices rose to 36 percent, which was the highest level in 40 years. On the other side of the ledger, more firms are planning near-term capital expansion, which could lead to increased productivity and help suppress inflationary pressures.

Michigan Consumer Sentiment Better Than Headline Suggests: The University of Michigan reported on Friday that its preliminary consumer sentiment reading declined to 82.8 in May. The survey showed lower levels for both current conditions and consumer expectations, although we believe they may be falling for the right reasons. Namely, the report showed an increase of inflation expectations, both over the next 12 months and looking out 5-10 years. If consumers take pause when prices are climbing, it pushes out spending and lets supply catch up with demand. The result of these actions can ultimately have a calming effect on prices.

THE WEEK AHEAD

PMI Readings in Focus: IHS Markit will announce its preliminary purchasing managers’ index (PMI) readings for both the U.S. and eurozone on Friday. These data offer the first broader economic gauges each month, and it will be worth noting whether the services sector continues to recover in Europe.

Housing Data on Deck: Shifting back to the U.S., we’ll get several looks at the state of the housing market next week, beginning with the May reading of the National Association of Home Builders (NAHB) index on Monday. The following day brings April housing starts and building permits, followed by existing home sales on Friday. The housing market remained resilient in many areas of the country throughout the pandemic, and builders are trying to meet demand, which has helped to drive an increase in prices of lumber and other commodities.

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Specific sector investing can be subject to different and greater risks. Commodity prices fluctuate more than other asset prices with the potential for large losses and may be affected by market events, weather, regulatory or political developments, worldwide competition and economic conditions. Investment can be made directly in physical assets or commodity-linked derivative instruments, such as commodity swap agreements or futures contracts.

Treasury Inflation-Protected Securities (TIPS) are securities indexed to inflation in order to help protect investors from the negative effects of inflation.