The global equity market slipped for a sixth consecutive week with the MSCI AC World Index falling 2.2%. In the United States, the tech-heavy NASDAQ dropped 2.8% while the S&P 500 closed the week 2.4% lower. Markets overseas experienced similar losses with European stocks tumbling 1.0% and Japanese stocks sliding 2.1%. The nominal 10-year U.S. Treasury yield retreated from recent highs – falling 20-basis-points to 2.92%.
The April consumer price index (or CPI) showed that inflation likely peaked at 8.5% in March. Investors and policymakers were hoping for a faster pace of deceleration, but the decline from 8.5% to 8.3% is still good news and likely the beginning of a lasting trend with inflation possibly falling to about 6.5% by year-end.
Heading into 2023, labor market data may become more important than inflation data with weekly initial jobless claims for unemployment insurance having potentially bottomed in March 2022. While the U.S. labor market remains tight, we wonder if weakening labor market data later in the year may test the Federal Reserve’s resolve to tackle inflation at any cost.
Coming in Hot
Nearly everyone, including the Federal Reserve, is probably tired of hearing about inflation, but let’s talk about it anyway. It does look like the consumer price index (or CPI) peaked in March. That is the good news. The bad news is that it did not show the kind of deceleration that investors were hoping for with headline inflation falling from 8.5% to 8.3% (versus consensus expectations of 8.1%). We doubt that the April consumer price index has created the case for a substantial stock market rally from here, but it may have helped to calm things down a bit with the S&P 500 rising about 3.3% and the NASDAQ up 5.4% in the two days following the report. Perhaps more importantly, the MOVE index, a measure of bond market volatility, has been falling since the start of May (see figure 1). For additional insights on why we believe the forward returns on U.S. Treasuries have improved, please see our, “CIO Strategy Bulletin | Understanding Markets and Inflation.”
When it comes to inflation, the CPI is still showing some unusual distortions that should normalize over time. The category with the highest month-on-month rise was unsurprisingly airfares, which jumped 18.6% in April, as travel has surged with covid restrictions being removed throughout most of the country. The category with the second highest prices was eggs. With food inflation at a record high, it is not surprising to see a food category near the top (see figure 2), but it may have less to do with supply chain issues and more to do with the current strain of bird flu that is lowering the chicken population (less chickens, less eggs). While those trends shouldn’t last, the downside is that shelter prices were up 0.6% during the month and that trend may remain in place for several more months as the shelter prices component of the CPI lags national home prices by about a year (see figure 3).
Fortunately, we are entering a period of easy inflation comparisons with the consumer price index having risen by over 0.8% in April, May, and June of 2021. That means we should see headline inflation continue to fall for at least the next three months with inflation potentially nearing 6.5% by year-end and 3.5% by the end of 2023. Still above the Fed’s 2% target but headed in the right direction.
Will Falling Inflation Change the Fed’s Trajectory?
Probably not immediately. Fed Chair Powell said last Thursday that, “the one thing we really cannot do is fail to restore price stability...the economy doesn’t work for anybody without price stability.”1 Given the Fed’s current rhetoric, it seems almost assured that the Fed will raise interest rates by 50-basis-points for at least the next two meetings (June and July). Beyond that, we could see a pause or perhaps a move towards 25-basis-point rate hikes. The September FOMC meeting may prove to be a critical meeting with its results potentially determining whether the Fed will be able to pull off an optimistic “soft landing” for the U.S. economy.
While all eyes are on inflation right now, it may be the state of the labor market that proves more important come year-end with weekly initial jobless claims an official component of the leading economic indicators index. Currently, just 1 out of 1,000 working age people are filing claims for unemployment insurance (see figure 4). However, initial jobless claims tend to bottom about 13 months before the onset of recession with the longest lead time being 22 months (see figure 5). If we assume that claims bottomed on March 19th 2022 at 166,000 (see figure 6), then the most likely timing for a recession would be April 2023 to January 2024.
In the past eight recessions, initial jobless claims rose by about 57,000 off their bottom before the U.S. economy entered a recession (the highest climb before entering a recession was 105,000 claims in 1979). If we use that range, then initial jobless claims between 223,000 and 271,000 might imply we are nearing a recession. Right now, weekly claims are at 203,000. This is just one metric to watch, but we think it’s probably a good one to keep an eye on. If something is going to give the Fed some pause, it will most likely be job losses (see figure 7).
Our Tactical Asset Allocation Remains Defensive
Our global equity overweight is largely in commodity hedges like natural resources, oil field services, and other defensive equities like dividend growers. We also believe that investors may wish to consider adding long-duration Treasuries (such as the 30-year U.S. Treasury) with yields likely to peak in 2022. We think that this type of defensive portfolio tilt will remain appropriate until growth fears fade. For additional portfolio insights, please see our Quadrant | The Late, Late, Late Fed Show.
What Should U.S. Investors Watch in the Week Ahead?
In the week ahead, investors will receive the April retail sales report which will provide a fresh look at the consumer with the consensus calling for sales to rise by 1.0% in April. Also on the economic calendar are U.S. industrial production and housing starts. Aside from retail sales, we suspect the big event of the week may be a Wall Street Journal interview with Fed Chair Powell on Tuesday.
|Index||Weekly Chg change in percent||YTDyear to date change in percent||12 Months 12 month change in percent||Div. Yield division yield in percent|
|Instrument||Weekly Chgchange||YTDyear to date||12 Months12 month change||Level|
|10-Year Treasury Yield (%)||-20 bps||140.8 bps||126 bps||2.92%|
|Index||Weekly Chg change in percent||YTD year to date in percent||12 Months||Div. Yield division yield in percent|
The Week Ahead
|5/17||8:30||Retail Sales Advance MoMMonth over Month||AprApril||1.0%||0.5%|
|5/17||8:30||Retail Sales Ex Auto and Gas||AprApril||0.7%||0.2%|
|5/17||9:15||Industrial Production MoMMonth over Month||AprApril||0.5%||0.9%|
|5/17||10:00||NAHBnational association of home builders Housing Market Index||May||75||77|
|5/18||8:30||Housing Starts MoMMonth over Month||AprApril||-1.9%||0.3%|
|5/18||8:30||Building Permits MoMMonth over Month||AprApril||-2.7%||0.4%|
|5/19||10:00||Existing Home Sales MoMMonth over Month||AprApril||-2.1%||-2.7%|