No Peak Yet
The rally taking shape in equity markets over the last two weeks has been brought to a screeching halt by another blistering hot inflation report. In the month of May, the consumer price index increased by 8.6% year over year and 1% month over month. The reading was higher than economists’ estimates and marked a reacceleration from April’s slight reprieve. Any illusion that inflation had peaked may now be shattered. In response to the report, stocks sold off to their lows on the year, and bond yields pushed towards their highs. It continues to be difficult for progress to be made against a Fed that increasingly looks to be behind the curve.
Within the inflation report, shelter costs increased by 5.5% on a year-over-year basis. This was the fastest pace of increase recorded in over 30 years. Persistent inflation in rents is of particular concern. It is a sticky category and represents a sizeable portion of the average household budget. Inflation here extends beyond short-term supply and demand disruptions and is a symptom of a more structural problem. There is a widespread shortage of housing across the country. With high prices, high rates, and no supply, it is no surprise that rents continue to rise.
Inflation in food and energy is also proving to be anything but transitory. Supply shortages continue to stem from the war in Ukraine. Pain continues to be felt at the grocery and gas pump for consumers. In turn, consumer sentiment has deteriorated. Surveys indicate that consumers are feeling their worst in years. However, spending has held up remarkably. Consumers are still working through their pandemic savings and have access to credit. This has limitations, though. The longer inflation persists, the more unlikely it is that the consumer will emerge unscathed.
There is a path to a soft landing still, but that path gets narrower with each hot report. The Fed needs to break inflation before they break the consumer. It is a challenging environment, and we continue to err on the side of caution. We still believe it is prudent to take refuge in stocks that are domestic, essential, energy immune, and that have pricing power.
Preston May, CBE®
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