Inflation running hot sent jitters through markets – is the fear justified?  Inflation, via the Fed’s favorite inflation gauge – the consumer price index or “CPI” – continued its rapid surge in June, rising at its fastest pace in nearly 13 years.  The CPI increased 5.4% from a year ago, the largest jump since just before 2008’s great financial crisis. Economists expected a 5% gain. If you remove food and energy prices, core CPI rose 4.5%, the sharpest move for that measure since September 1991 and well above expectations of 3.8%.

Our take: Sure, the inflation headlines are scary once again, but if you dig deeper, you’ll see that the data doesn’t imply that higher prices on most goods and services we all use routinely will show up, let alone persist. Here’s why: June’s CPI report shows – for the third straight month – that most (52%+) of the price pressures are in reopening sensitive categories like used cars, rental cars, vehicle insurance, lodging, airfares, and dining out.  If you throw in energy prices, that proportion rises to 66%. For some perspective, used car prices alone accounted for 20% of the year-over-year change in the CPI.

Despite the spooky inflation headlines, the makeup of the price increases means that the Fed can still subscribe to their “transitory” inflation belief and take their time in easing off the stimulus gas pedal.  If pressures begin to build in labor-slack sensitive services categories, the Fed may change its tune. In the meantime, as we’ve been saying for weeks now, expect the CPI to run hot all summer, as households flush with extra a couple trillion in savings are eager to spend after lockdowns, amid extreme supply shortages. For interest rates, it means that you can expect long-term rates to stay well within their current ranges through the fall.

Fun fact: Rents are roughly a third of the monthly CPI gauge. Even though last month’s CPI data showed that consumer rents are tame for now, the scenario may change should home prices continue their surge, and the back-to-work tide comes in this fall.

Powell and Yellen fired up the no-inflation PR train. During scheduled, widely anticipated testimony to Congress, Fed Chair Powell said that inflation has notably increased and will likely remain elevated in coming months before moderating. Powell added that America’s job market hasn’t recovered sufficiently for the central bank to reduce its support of the economy. He restated that Fed discussions are underway about when it might be appropriate to reduce – aka “taper” – the Fed’s $120 billion in monthly bond purchases. In support of Powell, Treasury Secretary Yellen echoed Powell’s comments, stating that she expects the American economy to see several more months of rapid inflation, although she also expects the recent startling inflation run to ease over time.

Our take: Despite the recent spike in inflation rattling everyone’s cages, creating more jobs is the Fed’s #1 priority right now. With roughly 7 million still unemployed when compared to the start of the pandemic, America’s job creation engine has a long way to go to make up for the slack. Until progress is made on the jobs front, you can expect the Fed to continue leaning into its easy-money, low interest rate stance no matter what inflation ends up doing. Don’t agree with us? That’s okay, the bond markets do, as evidenced in their lack of reaction to last week’s inflation data. If bond markets were really concerned by the data, long-term interest rates would have risen notably. In short, they didn’t.

Other data reinforced the view of a bumpy, post-pandemic road to recovery. The University of Michigan’s consumer sentiment index – a gauge of the overall health of the economy as defined by the always important consumer – pulled back last month amid accelerating inflation. Higher inflation reflects higher prices, which are now clearly eating away at consumer purchasing power in some respects.  Favorable buying attitudes are being eroded amid complaints about rising prices for homes, vehicles, and household goods. Many consumers, who alone are responsible for ~70% of US economic activity, will choose to delay purchases, rather than eliminate them.

Our take: As the jobs market slowly improves, we expect the reset in spending attitudes to prove temporary amid rising wages. In the meantime, rising home prices and equity markets, combined with accumulated savings, will support a strong baseline of consumer spending through the summer. Our belief is supported by the most recent data on retail sales, which showed a broad-based rise.