Peak Inflation?

Stocks gapped down at the open but quickly recovered. At the moment, the Dow is down 180 points and the S&P 500 is down .4%. Commodities are mixed (oil & crops down, gold & copper up). Bonds tried to rally but are modestly lower in price. Considering June’s CPI report (see below) markets’ reactions are surprisingly not terrible. Apparently, a lot of potentially bad news has already been priced-in.

The Consumer Price Index (CPI), which measures retail inflation, accelerated to a four-decade high of 9.1% in June. Economists were expecting something closer to 8.8%. Excluding the more volatile categories of food and energy, “core” CPI did decelerate a bit to 5.9% growth, but that’s still pretty high. The main culprits for higher inflation were gasoline (+11.2% from the prior month!), rent and food. New and used car prices began to fall a bit, but we were surprised to see that apparel and home goods prices actually increased. This report is obviously going to encourage the Federal Reserve to continue raising interest rates.

But I think the inflation situation may not be as threatening as the report suggests. How do we reconcile the fact of higher inflation with huge commodity price declines over the last few weeks? Oil has fallen to $96/barrel from $120/barrel. Copper is down 30%. The MSCI Global Agricultural Producers fund (VBEGI) is down 18%. Bond and commodity futures markets are signaling lower inflation going forward.

I need to mention the US dollar, which has strengthened against most other major currencies. Bloomberg’s Dollar Index is up 12.5% this year, which is unusual. Maybe this move suggests that the Federal Reserve is more determined than other central banks to tamp down inflation with higher interest rates. Maybe it reflects traders’ belief that US economic growth will ultimately be stronger than in Europe or South America once this rate normalization process is over. But while a strong currency is generally a good thing in the long run, we have to recognize that it also temporarily depresses the value of sales and profits for US companies doing business overseas. Microsoft (MSFT) issued a profit warning recently to that effect, and we expect to hear more of the same in the near future.