Inflation data spooks the markets (Daily analysis 13.05.2021)

Surprisingly high inflation readings in the USA trigger another round of market turbulence. Their main source is the bond market and equity markets, with the particularly sensitive technology sector at the forefront. The dollar had a slightly less positive reaction.

In April, the values of the main US inflation indexes reached truly space-like levels. Compared to March, consumer prices increased by 0.8%, while core prices (excluding fuel and food) were as much as 0.9% higher than in the previous month. This translates into annual growth rates of 4.2% and 3%, respectively, which are very hard not to ignore. Price pressures in April were not only the strongest in about a decade but also significantly exceeded market expectations (0.2-0.3% for month-on-month readings).

US inflation skyrocket

Currently, the price path in the United States is influenced by the spread of deferred demand across an opening economy with bottlenecks and disrupted supply chains, i.e. typical supply-side factors. The categories that have significantly boosted the indexes have been, for example, (again) car rental rates and used vehicles. The increase in their prices should be connected with enormous demand. It has its source in problems with the availability of new cars (production disruptions caused by shortages of, i. a., microprocessors), which have a colossal impact on prices when rental companies restore their fleets. It may sound unbelievable, but second-hand cars account for a third of the significant increase in core inflation. Hotel prices and increases made by airlines also have been a big contributor.

The market or the Fed - who is right?

The next round of tug-of-war between investors and the Federal Reserve is about to begin (via the Treasury bond market). The former are increasingly doubting that the inflation spike will be temporary. Obviously, the latest data are water to the mill of such expectations. On the other hand, the central bank continues to stand firmly in line with its policy and wants to maintain an extremely mild policy for as long as possible. The chosen course of action requires consistency. A sudden change of strategy suggesting a quicker cut in the monetary support and a nearer hike in interest rates (currently suggested only in 2024) would cause strong market turbulence.

The top priority in the Fed's strategy is to bring the labour market back to a pre-crisis condition as quickly as possible. The data for April suggest that this may take longer than expected, but the labour demand is still very strong (record number of hiring openings, companies reporting problems filling vacancies). Among the factors to monitor that would help assess the nature of the price process are data on wage pressures and residential rental rates. The Federal Reserve immediately began to hear from the esteemed Richard Clarida, as well as Raphael Bostic, who warned in their scheduled speeches that it would be a mistake to draw conclusions after a single reading. They reminded that in order to change the policy, a whole series of readings are needed that would indicate that inflation may be getting out of control. Policymakers consider the recent data as pandemic disorder and warn investors that the path of inflation will be subject to very strong returns in the months ahead. The underestimation of high inflation persists, and the Fed is not going to drop its inflation mantra anytime soon.