FINANCIAL MARKET UPDATE 7.13.2021

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

THE INFLATION DEBATE CONTINUES

Inflation continues to be one of the main storylines gripping the markets in 2021. The question isn’t if we will see sharp price increases or not, as they have been spiking higher for months. Rather the debate centers on whether the increases result from transitory factors, or if they will persist. The answer may have a significant impact on the economy and the markets. The Federal Reserve has maintained a view that the elevated inflation readings will be temporary. Their reasoning relates to labor market issues, supply chain disruptions and a misleading comparison of current prices with those of the weak economy a year ago. Other economists, however, think elevated inflation is here to stay. If the latter camp is correct, the Federal Reserve may be forced to tighten monetary policy sooner than expected, which would dampen economic activity and likely pressure stock and bond prices.

This morning, the Bureau of Labor Statistics published the Consumer Price Index (CPI), a popular inflation measure, for the month of June. While economists surveyed by the Wall Street Journal were expecting a modest slowdown from the May figure, the published data came in notably higher. On a year-over-year basis, prices increased by 5.4%, which is the fastest increase since the summer of 2008 when oil pushed to $150 per barrel. Core CPI, which strips out the volatile food and energy components, increased by 4.5%, making it the fastest pace since 1991.

On the face of it, the updated data appears to support the idea that rapid inflation is here to stay. Still, some factors suggest it’s too early to begin worrying. For example, used cars and truck prices have been rising rapidly due to a chip shortage that has choked off the production of new vehicles. The price for used autos has increased by 45% over the last 12 months and accounts for roughly a third of the overall inflation figure. Additionally, significant pent-up demand for travel and other services has been unleashed as the nation’s vaccination program continues. This has put upward pressure on the price of everything from fuel to airline tickets. Finally, the ‘base effect,’ or the comparisons between current prices and those of last year when the economy had just exited widespread lockdowns, should begin to fade away as we enter the fall.

At its most recent monetary policy meeting, members of the Federal Open Market Committee (FOMC) published their updated ‘Summary of Economic Projections.’ The projections aggregate the independent view of each member. While these projections do not represent an actual consensus forecast, they still provide some information on what the committee is thinking. The inflation measure included in the projections is the Personal Consumption Expenditures (PCE), which is the Fed’s preferred gauge. As you can see in the below table, the Fed expects inflation to run above its 2% target for 2021 and then decline in subsequent years. Again, this reflects the Fed’s view that inflation will be temporary.

Source: Federalreserve.gov, released on 6/16/2021. Yellow highlight added by me.

Investors in aggregate seem to be subscribing to the Fed’s view. Market-based measures generally suggest inflation will average just above the Fed’s 2% target in the coming years(1). Other data series that previously spiked but have since declined include the M2 money supply and lumber prices. Finally, even after the CPI data was published this morning, bond yields remain more or less unchanged. Generally, you would expect yields to rise with inflation fears.

It’s impossible to know how this plays out. The Fed seems to have convinced the market that inflation pressures are temporary, or at minimum, it has the tools to tame it if it’s not. The inflation debate will likely continue to garner headlines in the coming months.

1. The 10-Year Breakeven Rate, a common market-based measure of inflation expectations was at 2.33% as of 7/12/2021, per the FRED database.

WEEK IN REVIEW

  • Earnings season gets underway this week with a few major US banks reporting results. Earnings estimates for the S&P 500 currently reflect a staggering YoY growth rate of 64%, largely due to economic weakness at this time last year. If these estimates prove to be accurate, it will be the fastest YoY growth rate since Q4 2009, when the economy was recovering from the Financial Crisis.
  • Mortgage rates have followed the 10-Year Treasury yield lower. According to Freddie Mac, the national average 30-year fixed-rate mortgage rate declined to 2.9% last week. That is the lowest level since February.
  • Economic data to watch for this week includes jobless claims, industrial production and capacity utilization on Thursday. On Friday, we will get an update on retail sales, business inventories and consumer sentiment.

ECONOMIC CALENDAR

Source: MarketWatch

HOT READS

Markets

  • ‘This feels like 1999’: Global Start-Up Funding Frenzy Fuels Fears of a Bubble (CNBC)
  • Earnings Season Starts With Sky-High Stock Prices and Sky-High Expectations (CNBC)
  • Consumer Price Index Summary (BLS)

Investing

Other

  • The Uneven Odds for Promotions With Hybrid Work (WSJ)
  • The Invisible Addiction: Is It Time To Give Up Caffeine? (The Guardian)
  • Bezos and Branson are Going to Space! Or Maybe Not (Wired)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

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JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 12+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. He is also responsible for portfolio trading, research and thought leadership as well as analytics and operational efficiency for the Firm's Financial division. He lives in Omaha, NE.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

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