No peak in sight as CPI hits fresh 40-year highs
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A dark dose of reality greeted markets Friday morning as May CPI data topped expectations yet again. U.S. inflation reached its highest level since December 1981 as the consumer price index surpassed 8.6%. Investors and consumers alike are now looking squarely at the Federal Reserve and Chairman Powell, who will likely need to take an even more hawkish tone and raise interest rates more aggressively than the three 50bp moves already priced in for June, July, and September.
Inflation accelerates at the fastest rate since 1981, and consumers continue to bear the burden
Inflation in the United States continues to run rampant. The consumer price index unexpectedly increased to 8.6% in May, easily surpassing market estimates of 8.3%. Core CPI, which excludes volatile food and energy prices, also topped expectations at 6%. In response, US10Y surpassed 3.27% Monday morning, its highest yield since 2011, as investors anticipate even more aggressive rate hikes by the Federal Reserve.
The news will not be well received by American consumers, who continue to bear the brunt of record prices across nearly every industry. Energy prices, including gasoline, fuel oil, electricity, and natural gas rose 34.6%, the most since September 2005, while food costs surged 10.1% year-over-year, largely driven by increases in the price of meats, poultry, eggs, and fish. Other factors leading to the increase included the cost of shelter (5.5%), household furnishings (8.9%) used cars and trucks (16.1%), and the cost of airline fares (37.8%).
With consumers reeling from record prices at the pump, throughout their local grocery stores, and within their homes, the unexpected spike in inflation signals to investors that more hawkish action will likely need to be taken by the Fed. Given that inflation has yet to reach a clear “peak,” aggressive tightening will likely be on the table and Chairman Powell may be forced to increase rates faster than planned in the coming months. Markets have already squarely priced in 50bp hikes in June and July, with September increasingly more likely.
(Related insight: Read the article, "Hedging future fixed-rate debt")
ECB hawkishness, bleak growth outlook driving Euro volatility
On Thursday, the European Central Bank formally announced that it fully intends to begin hiking interest rates at July’s policy meeting and upon completion of its net asset purchase under its asset purchase program on July 1. The news was in line with investor expectations, given that annual consumer price inflation across the eurozone reached a new high of 8.1% in May.
The Governing Council confirmed that it will raise rates by 25bps during the body’s next gathering in mid-July and signaled that steeper hikes may be on the horizon at its September meeting and beyond as “a gradual but sustained path of further increases in interest rates will [likely] be appropriate.” The ECB also downgraded European growth forecasts and revised its inflation outlook upward through 2024. Euro depreciated on the news at a three-week low of $1.05 as investors come to terms with an increasingly dark European economic outlook.
The week ahead
Investors will closely monitor the market’s reaction to hot CPI numbers. On Wednesday, the U. S. Commerce Department will release retail sales data and Chairman Powell will host a press conference. The U.S. Department of Labor will release Jobless claims on Thursday.
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