In a Nutshell: Consumer Price Index – A Big Surprise

By Ken Herman

"The evidence is growing that this market knows no fear. There has been no 5% correction (on a closing basis in the S&P 500) since before the last election."

June statistics provided another huge jump in (CPI) inflation numbers!  While June may also have been another month where excluding this and that might make inflation look transitory, the Fed’s patience will likely be tested.  Headline CPI rose 0.9% in June (from May) for a 5.4% year-over-year gain.  This was well above the 0.5% consensus inflation expectation for June. Core CPI (ex-food and energy) also rose 0.9%, for a 4.5% yearly increase, also above that respective 4.0% consensus.

These statistics represent the largest monthly and yearly gains in these headline inflation indexs since 2008, as well as the biggest year-on-year core increase since 1991.  How long will it take for these price increases to subside if this is transitory?  If it takes many more months (before inflation quits dramatically increasing) could inflation expectations become unanchored?

Every month of bottlenecks and capacity issues also fuels doubt that increased inflation is temporary. Does it make sense that some of what has been driving high inflation so far this year has yet to work itself out?  For example, it should be no surprise that the ongoing chip shortage hasn’t been resolved, nor is it likely to be any time soon.

Members of the FOMC who already think it’s time to slow inflation expectations down (by setting a taper timeline) should find new ammunition in this (CPI) report.  One notable thing about this market is that it can’t seem to make up its mind about whether inflation is going to really take off or has already peaked.  If you listen to the Fed, the second quarter will mark the highest rate for inflation we’ll see.  They apparently think it should cool off in the months ahead.

But if you listen to some other notable pundits – like major fund managers Ray Dalio and Mohamed El-Erian, or former Treasury Secretary Lawrence Summers – then inflation is growing.  It took some time, but the Fed has finally acknowledged rising inflationary forces, as they raised their 2021 forecast to 3.4% from 2.4% in May.

Mohamed El-Erian, chief economic advisor at Allianz, told CNBC last week, “If you were actually to look at the numbers on inflation, you would start having serious doubts in your mind as to how transitory inflation is. But as long as the Fed believes it’s transitory, that is what matters for markets”.  Even as the stock market has apparently overcome its inflationary fears by setting new records, there are concerns in America about input costs, wage pressures, as well as Fed policies. The Fed’s favorite price gauge, the personal consumption expenditures price index, excluding the volatile food and energy sectors, rose 3.4% in May from a year ago, the highest level since 1992 and well above the central bank’s 2% target.

As investors look to the second half of 2021 for clues, expected positive economic data may provide the fuel for a rally to carry us higher (despite ongoing inflation).  The notion of massive Congressional spending, which coincides with further QE and the tempered structural inflation expectations, provides a long glide path for stocks to continue to rally. Either the bond market is wrong or Ray Dalio, Larry Summers, and Mohamed El-Erian are wrong on the inflation picture, or there is just too much money which needs to go somewhere.  Low yield bonds may be an uncertainty hedge.

The evidence is growing that this market knows no fear. There has been no 5% correction (on a closing basis in the S&P 500) since before the last election. The S&P 500 has set seven all-time record highs in a row – the longest streak since 1997. We recently saw new highs to the once-struggling NASDAQ and Dow Industrials; and, record breaking is anticipated to continue.  Plus, we are beginning to hear from major companies regarding their second-quarter earnings. How good will they be? Very good!

Analysts were way off the mark in forecasting the first quarter of 2021.  At the beginning of the year, the consensus was that S&P profits would be up 16% in the first quarter (vs. the same quarter in 2020), but first-quarter profits for the S&P 500 were up over 48% in the opening quarter. At one point, Wall Street thought that would be the all-time high growth rate, but it looks like this quarter will surpass Q1 by a long shot.