“Staggering.” “Ugly.” “Brutal.” And …. “out-of-date.”
Those are some of the words that investors, analysts — and even President Joe Biden — used to sum up the June consumer price index report released on Wednesday. The report produced a 9.1% annual headline rate, an almost 41-year high, that surprised financial markets by coming in even hotter than either economists or inflation-derivatives traders had expected.
Falling gasoline prices since mid-June still give some in financial markets and the administration hope that July’s inflation data won’t look nearly so bleak, but there’s a major caveat: Even after factoring in the drop in gas prices, CPI fixings traders, who’ve been closer to being right than just about anyone for the past year, still expect three more 8%-plus CPI readings — 8.6% for July, 8.3% for August, and 8.2% for September. That, in turn, should translate into more of the same financial-market moves as those seen on Wednesday: growing expectations for further aggressive rate hikes by the Federal Reserve, a more deeply inverted Treasury curve, and further selloffs in stocks.
“Inflation has become increasingly more entrenched and the Fed has committed to bringing inflation back down,” said Chris Zaccarelli, chief investment officer of Independent Advisor Alliance in Charlotte, N.C. “To the extent that we keep seeing elevated inflation prints –– e.g. especially over 8%, but anything at 4% or higher — the Fed is going to have to be more aggressive” with its rate-hike plan.
Before Wednesday, markets expected the Fed to raise rates by 75 basis points at its July 26-27 meeting and then hike by 50 basis points or less in subsequent meetings, Zaccarelli wrote in an email to MarketWatch. “The big change in that path, given the inflation data today and future projected inflation, is that the Fed is going to need to raise rates by 0.75% or more over the next couple of meetings.”
One implication of an even more aggressive rate-hiking schedule “is that the stock market is going to face an increasing headwind and that is likely to keep stocks from recovering for a longer period of time,” said the chief investment officer. “It’s entirely possible that the stock market doesn’t fully recover until 2024, so investors are going to need to get adjusted to the new normal of a sideways— or down —market that doesn’t bounce back within 6-12 months of falling from its previous all-time high.”
Lower gas prices over the past month are the main reason why Biden described June’s 9.1% headline rate as “out-of-date,” though still “unacceptably high.” The administration went so far as to hold a briefing for reporters on Tuesday, a day before the CPI release, where one senior official said gas prices have been falling to around $4.66 or $4.68 a gallon since June 14, from an average price of $4.92 a gallon earlier last month.
But gas prices can be volatile and swing suddenly in the other direction, too. That left many commentators focused on Wednesday’s surprisingly hot number. Zaccarelli of Independent Advisor Alliance called it “staggering.” David Russell, vice president of Market Intelligence at TradeStation Group, said it was “brutal,” while Cliff Hodge, chief investment officer at Cornerstone Wealth, used the word “ugly.” Rusty Vanneman, chief investment strategist at Orion Advisor Solutions, concluded that “peak inflation will have to wait.”
If anything, market participants were ready to call a peak in something else. “We believe we are near peak confidence in the Federal Reserve’s credibility, as inflation data once again continues to exceed expectations,” said Nancy Davis, founder of Quadratic Capital Management in Greenwich, Conn., with roughly $1.7 billion in assets.
“The Fed was completely wrong about inflation being transitory and waited way too long to start hiking interest rates,” she said by email. “The Fed is still behind … It’s unclear how the central bank gets the inflation genie back in the bottle without a lot of pain along the way.”
The likelihood of a full percentage point rate hike by Fed officials at their next meeting in two weeks jumped to 51% after Wednesday’s data, up from 7.6% on Tuesday, according to the CME FedWatch Tool. Such a move would take the Fed’s main interest-rate target to between 2.5% and 2.75% from a current level between 1.5% and 1.75%. Meanwhile, fed funds futures traders see a 49% chance of a 75 basis point rate hike.
Growing expectations for an even more aggressive response from the Fed to inflation boosted the 2-year Treasury yield
to 3.1% and narrowed its spread to the 10-year rate
to as little as minus 19.6 basis points at one point — leaving the Treasury curve deeply inverted in a worrisome sign of the outlook.
Gains in 2-month and 3-month bills, as well as the 1-year rate, outpaced the rest of the curve as a reflection of investors’ shifting expectations for the Fed’s near-term policy path.
Meanwhile, all three major U.S. stock indexes were lower in the afternoon. Dow industrials
the S&P 500
and the Nasdaq Composite
are respectively nursing year-to-date losses of 15%, 20% and 28% as inflation continues to run rampant and shows no definitive signs of easing.
It was only a month ago that the May CPI report, with an 8.6% annual headline reading, produced what Nancy Tengler of Nashville-based Laffer Tengler Investments called a “catastrophically bad” outcome for Americans — which forced the Fed to suddenly abandon its plans to deliver a 50 basis point hike in favor of a 75 basis point move in June.
The current headwind facing the stock market is “unlike anything investors have seen in 13 years, although we have witnessed this type of longer bear market in 2007-2009 and also in 2000-2002,” said Zaccarelli of Independent Advisor Alliance, which oversees $9 billion. “So it isn’t unprecedented even in this century, despite being foreign to many investors who have less than 13 years of experience.”