Has U.S. Inflation Peaked?

The Bureau of Labor Statistics reported that the consumer price index (or CPI) rose from 7.9% in February to 8.5% in March – the highest reading since December 1981 (see figure 1).  Energy prices surged 32% year-on-year, food prices soared 8.8% year-on-year, and core prices, which exclude both energy and food prices, jumped 6.5% year-on-year. These prices were well above the level that Federal Reserve officials believe is consistent with price stability, which is why they feel the need to act with interest rate hikes and a drawdown of the balance sheet. However, there are some signs that we may be nearing peak inflation…or at least a plateau.

This chart shows the United States Consumer Price Index year-on-year percent change from 1955 to 2022 year-to-date.

One of the more positive aspects of the inflation report was that used car prices fell 3.8%. Absent the drop in used car prices, Citi Research’s economists estimate that core inflation would have been 0.2% higher month-on-month. Combined with base effects, falling used car prices could cause core inflation to pull back on a year-on-year basis next month. Unlike volatile energy prices, it is important to note that the spike in used car prices is likely not going to repeat with wholesale prices suggesting a continued downward trend (see figure 2). Crude oil prices have also come off their highs with West Texas Intermediate averaging around $100 per barrel through mid-April (see figure 3). Food prices, on the other hand, are staying elevated and shelter prices continue to firm. Combined, food and energy prices make up about 20% of the CPI. These dynamics are likely to leave prices elevated for some time, but Citi Research’s economists think that consumer prices may fall to 8.2% year-on-year in April. By summer, investors could be looking at 7.5% year-on-year and by the end of the year, prices could fall within a range of 5.5% to 6.0% higher year-on-year.

This line chart shows Manheim Wholesale Used Vehicle Price Index versus Used Car and Truck Prices year-over-year percent change from 1997 to 2022 year-to-date.

This line chart shows the price in dollars of West Texas Intermediate Crude Oil from February 2022 to April 2022.

Interestingly, Citi Research’s economists are largely in line with what consumers have been reporting as well with the University of Michigan’s one-year ahead inflation expectations coming in below expectations at 5.4% in the latest report (see figure 4). Core inflation; however, could still be sticky with rising home costs likely to keep the metric above 5% through year-end (see figure 5). While welcome, these potential declines are likely not enough to make the Federal Reserve reverse its decision to tightening monetary policy, but it appears to be trending in the right direction.

This line chart shows the U.S. Consumers' One-Year Ahead Inflation Expectations by percent, from 1978 to 2023 year-to-date.

This line chart shows national home prices versus the percent of Consumer Price Index of owner's equivalent rent of primary residence from 2000 to 2022 year-over-year.

We are also encouraged to see Citi’s Inflation Surprise Index moderating while Citi’s Economic Surprise Index has been solidly in positive territory since mid-February (see figures 6 and 7). These metrics suggest that inflation prints are surprising by a smaller margin while economic data are beating expectations by a wider margin. This may not fully include the impact of the Russia Ukraine conflict, but the U.S. economy looks resilient thus far. For further information on potential economic scenarios, please our CIO Strategy Bulletin | Three Scenarios for the Economy and Markets.

This line chart shows Citi's U.S. Inflation Surprise Index from 2018 to 2022 year-to-date.

This line chart shows Citi's U.S. Economic Surprise Index from 2018 to 2022 year-to-date.

What Does This Mean for Financial Markets?

We have written in detail about how expectations for an aggressive Fed tightening cycle has led to an inversion of the yield curve, but that U.S. stocks often still rise during tightening cycles. In fact, during the last seven Fed tightening cycles, U.S. stocks have risen every single time during the tightening cycle by an average of about 14.5% over a period of about two years (see figure 8).

Fed Tightening Period			Fed Funds			S&P 500			NBER First Recession Month	Number of Months Recession Occurred After The Start of Tightening	Real GDP Drop (%)	Policy-Induced Recession?
Start	End	Type of Cycle	Start	End	Chg Change in FF (bps)	Start	End	% Chg Change
Sep-65	Nov-66	Slow	4.02	5.76	174	89.38	80.99	-9.4%	--empty	--empty	None	No
Jul-67	Aug-69	Fast	3.79	9.19	540	93.01	94.18	1.3%	Jan-70	30	-0.6%	Soft-ish landing
Feb-72	Jul-74	Fast	3.30	12.92	962	105.24	82.82	-21.3%	Dec-73	21	-2.7%	Hard landing
Jan-77	Apr-80	Fast	4.61	17.61	1300	103.81	102.97	-0.8%	Feb-80	37	-2.2%	Hard landing
Jul-80	Jan-81	Fast	9.03	19.08	1005	119.83	132.97	11.0%	Aug-81	12	-2.1%	Hard landing
Feb-83	Aug-84	Slow	8.51	11.64	313	146.80	164.42	12.0%	--empty	--empty	None	No
Mar-88	Apr-89	Fast	6.58	9.84	326	265.74	302.25	13.7%	Aug-90	28	-1.4%	Soft-ish landing
Dec-93	Apr-95	Fast	2.96	6.05	309	465.95	507.91	9.0%	--empty	--empty	None	No
Jan-99	Jul-00	Fast	4.63	6.54	191	1248.77	1473.00	18.0%	Apr-01	26	-0.1%	Soft-ish landing
Jun-04	Jun-06	Fast	1.03	4.99	396	1132.76	1253.12	10.6%	Jan-08	43	-3.8%	Monetary Policy Not Primary Driver
Oct-15	Jan-19	Slow	0.12	2.40	228	2024.81	2607.39	28.8%	Mar-20	53	-10.1%	Monetary Policy Not Primary Driver
Average			4.06	9.64	522	526.92	618.37	6.6%	N/A	31	-2.9%	N/A

This table has data that describe Past Fed Tightening Cycles versus Economic and Market Performance over several time windows from 2006 to 2019.

When it comes to the fixed income market, the sharp ascent in Treasury yields may be starting to ease. As Citi Global Wealth’s Chief Investment Strategist Steven Wieting has pointed out recently, rates tend to peak around the time of yield curve inversion. This has been a consistent pattern over the last several decades (see figure 9). There is probably some risk in calling a peak for Treasury yields as investors have never experienced such an aggressive runoff of the Fed balance sheet, but the Fed’s hawkishness should be increasingly priced in by now. For a deeper dive on fixed income markets, please see our CIO Strategy Bulletin | A Brighter Future for Fixed Income?

This line chart shows the Ten-Year and Two-Year U.S. Treasury Yields in percent from 1977 to 2022 year-to-date.

What Should U.S. Investors Watch in the Week Ahead?

In the week ahead, investors will receive a slew of housing data for the month of March including the NAHB Housing Market Index, building permits, and existing home sales. With mortgage rates climbing to above 5.0%, investors will be watching for any signs of weakness in the housing market. Aside from that, first quarter 2022 earnings will kick off in earnest with S&P 500 earnings-per-share (EPS) expected to rise by about 5.8%. Excluding Financials, EPS are forecast to rise by 13.5%. We will be watching closely for any negative guidance related to the Russia Ukraine conflict and how inflation may be impacting margins. Overall, we expect S&P 500 EPS to climb by about 8% in 2022.

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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
Dow Jones	-0.8%	-5.2%	1.2%	1.9%
S&P 500	-2.1%	-7.8%	5.3%	1.4%
NASDAQ	-2.6%	-14.7%	-4.9%	0.7%
Instrument	Weekly Chgchange	YTDyear to date	12 Months12 month change	Level
10-Year Treasury Yield (%)	12.7 bps	131.7 bps	125 bps	2.83%
Gold ($/Oz.)	1.6%	8.1%	12.1%	$1,978.2
Oil ($/bbl)	8.8%	38.9%	68.5%	$106.95

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This table shows returns for various USA equity markets and select assets, in weekly, year-to-date and 12 month changes.

Index	Weekly Chg change in percent	YTD year to date in percent	12 Months	Div. Yield division yield in percent
Global	-1.7%	-8.6%	-1.7%	1.9%
Europe	-1.2%	-10.0%	-4.8%	2.9%
Japan	-1.2%	-13.2%	-15.6%	2.3%
Emerging Markets	-1.2%	-9.2%	-15.1%	2.7%

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This table shows the US Stock Market Returns and Select Assets and International Stock Market Returns.

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Date	Time	Event	Period	Consensus	Prior
4/18	10:00	NAHBnational association of home builders Housing Market Index	AprApril	77.0	79.0
4/19	8:30	Housing Starts	MarMarch	1740k thousand	1769k thousand
4/19	8:30	Building Permits	MarMarch	1820k thousand	1859k thousand
4/20	10:00	Existing Home Sales	MarMarch	5.78m million	6.02m million
4/21	8:30	Initial Jobless Claims	4/16/2022April 16, 2022	180k thousand	185k thousand
4/21	10:00	Leading Index	MarMarch	0.3%	0.3%

This table lists a number of key economic events, analysis reports and forecasts from influential institutions.

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