Inflation: Hot, Hot, Hot

By TRG Advisors on June 13, 2022

8.6% May CPI

Inflation expanded broadly in May, with 70.6% of the CPI basket increasing at a 4% annualized monthly rate. Leading categories included food, energy and services.

Chart 1: Selected CPI Categories (% y/y)¹

While some economists expected peak inflation to be reached earlier this spring, inflation has proven persistent, with elevated demand shifting to services – 70% of consumer spending is in services – including higher rents, transportation and medical. The consumer is getting pinched by inflation, but the good news is that the job market is providing some support.

We’re paying attention to higher wages driven by the tight labor market. Higher wages lend some comfort as an offset to higher inflation – if only partially. The tight labor market contributed to unit labor costs increasing +12.6% in the first quarter, the NFP report of wages up 5.2% y/y and core PCE at 4.9% y/y. Another strong month of job openings speaks to the tight labor market, with the JOLTs figure at 11.4 million. The number of jobs available is higher than unemployed people – a dynamic that has been in place for the better part of the last year. Along with rents, wages tend to be a sticky contributor to inflation.

Central Banks Committed to Fighting Inflation

The Fed has only raised the Fed funds rate by 75 bps to date. The next two meetings are expected to be 50 bps each in an effort to slow the pace of demand, with some economists anticipating a 75 bps hike in June or July. The Federal Open Market Committee (FOMC) meets this Wednesday to provide an update on their path forward. We do not rule out another 50 bps in September given the elevated levels of inflation, which will likely persist for some time.

The European Central Bank (ECB) joined the global alliance toward fighting inflation last week by announcing a 25 bps rate hike in July. European CPI grew by a record high 8.1% in May. The ECB indicated another hike is likely for September but stopped short of announcing the scale – opting to wait and analyze the data. Europe has greater exposure to the geopolitical turmoil in Ukraine and a looming economic slowdown without the strong jobs market seen here in the U.S.

CPI Drives Treasury Sell-Off

Friday’s rapid Treasury sell-off occurred in the wake of the hottest CPI print in more than 40 years. Despite all yields shooting higher, the short-end and belly of the curve saw the greatest moves, causing a flattening effect, as seen by 5s/10s spread inverting and 2/10s falling below 10 bps. Bear steepening was seen in Municipal yields, as the short-end dropped 1-3 bps while the long end rose 10-20 bps. Corporate spreads widened meaningfully; High Yield by 48 bps and Investment Grade by 36 bps.

Atlanta Fed Q2 GDP

The Atlanta Fed GDPNow tracker, a real-time estimation tool for currentquarter GDP, is trending downward. Its initial estimate for an annualized 1.3% gain in Q2 is now just 0.9%. It was 2.1% just a month ago, which speaks to the rapid pressure on the consumer due to extraordinary levels of inflation. This is clearly on the radar for investors. Right now, we don’t anticipate a 2022 U.S. recession due to the resilient consumer and available job opportunities, but 2023 is more uncertain.