Another solid week for global equities despite interest rates hooking higher. Inflation appears to be moderating at a decent clip, and this combined with resilient growth data offset a relatively hawkish Fed meeting. First, let’s recap the recent inflation news.
Last week the ISM report came out, and embedded in this is a measure of services inflation. As you can see below, it has moderated significantly. Typically, consumer prices follow this trend with a lag.
This week we learned about consumer prices in May. The headline number was up +0.1% for the month and +4.0% year-over-year, a tick below expectations. If you exclude food and energy, core CPI was up +0.4% for the month and +5.5% year-over-year, as you can see below. There weren’t many surprises in this report. Core prices were boosted by a second consecutive +4.4% increase in used car prices.
Headline inflation is slowing much more quickly than core due to the recent decline in energy prices, but slowing rental growth should lead to slower core inflation in the months to come.
Finally, inflation at the manufacturing level came in below expectations. Wholesale prices fell -0.3% in May — the third drop in the past four months — while prices are up + 1.1% from year ago levels. That’s the lowest reading since December 2020.
It’s worth pointing out that inflation is still well above the Fed’s target, and we may never get below the target this cycle. But equity investors are more focused on the rate of change than the absolute level at this point.
The Fed Keeps its Options Open
The Fed talking heads have been pretty vocal about taking a pause at this week’s meeting, and they didn’t disappoint. On Wednesday they announced that their key policy rate would remain unchanged at 5-5.25%. However, the communication maintained a hawkish tone, underlining that the pause does not necessarily mean an end of the tightening cycle. Fed Chair Powell stressed that the July FOMC meeting will be a “live meeting”, i.e., it will feature an active hike/hold policy rate decision that has not yet been made.
If there was a surprise on Wednesday it was that the much-maligned dot plot showed rates peaking at over 5.5% this year, implying two more quarter-point rate hikes this year.
Two year yields in particular spiked higher on this news as bond investors started to price in a more hawkish rate scenario for the rest of the year.
How likely is another rate hike, possibly in July? It’s really a tough call at the moment. There’s some thought that the Fed can’t possibly hike anymore now that the Funds rate is at 5%, but in reality, policy really isn’t that restrictive yet. The chart below shows the difference between the Fed Funds rate and core CPI inflation. Rates were negative in real terms (after inflation) during the whole COVID period (and for quite some time before that), and have just got back to flat.
Will inflation slow enough that real rates move into positive/restrictive territory all on their own? That’s the $64 trillion dollar question.
It’s worth noting that the answer in both Canada and Australia is no. Both central banks paused a little while ago, but resumed hiking this month due to sticky inflation rates.
We certainly can’t rule out this scenario in the U.S.
(Other) Charts We Found Interesting
The S&P 500 is being held aloft by the seven largest market-cap companies. If you equal weight, the index returns are far more muted.
The AI frenzy in chart form.
When you think about re-shoring and the energy transition, this puts things in perspective. Corporate capex spendings is soaring.
California has the dubious distinction of having the top fourteen least affordable places to look for a starter home.
What happened to the banking crisis? First and foremost, deposits stopped fleeing the banking system (probably) because banks are paying a lot more for said deposits.
Crude oil prices have been struggling lately despite two production cuts from OPEC+. Saudi Arabia’s latest cut of 1 million barrels-a-day (mbd) will take their daily production down to roughly 9 mbd.
As I get older I keep staring at this chart more and more.
The wildfire smoke on the east coast conjured up some interesting optical illusions last week!!
Have a good weekend
Chief Investment Officer
Gemmer Asset Management LLC
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