Inflation And What The Fed Is Saying

Inflation has been on the rise. Investors are not as interested in what’s happening now as they are in what’s happening next. Meanwhile, the Federal Reserve (Fed) shared its views at the conclusion of its last policy meeting on Wednesday, June 16. And while the Fed’s position that inflation is likely to be transitory has become stronger, not weaker, Fed members have seemingly different opinions on the future path of monetary support.

Inflation has been on the rise. Everyone knows it and feels the impact with every purchase. The Consumer Price Index (CPI) spiked to 5.0% year over year in May, the most since 2008, while core CPI (excluding food energy) hit 3.8%, the highest since 1992. Inflation has been rising and the Fed is watching. How will markets react to any potential inflation over the next year?

We do know this: Markets will be looking forward, not backward. By the time something becomes a “thing,” a meme, or makes a magazine cover, market participants are often past it, as we discussed in our June 16 blog, Why Inflation Worries Likely Just Peaked. Markets are no longer watching to see if inflation will spike. It already has. In fact, since the big upside surprise in the April inflation data, released May 12, many inflation-sensitive assets have been underperforming. Copper? Down. Lumber? Down. The 10-year Treasury yield? Down. Market-implied inflation rates? Down. Gold? Down.

At the conclusion of its last policy meeting on June 16, the Fed shared its view on what may be coming for inflation. In its updated forecasts, the Fed acknowledged it had missed on inflation expectations, upgrading its preferred core inflation forecast for 2021 from 2.2% all the way up to 3.0%. That’s a large jump, but that’s based on what’s behind us. The forecast for the same index in 2022 and 2023 scarcely moved, at 2.1% for both years.

Inflation is certainly still capable of coming in hotter than expected. The difference between now and earlier this year is that inflation expectations are already elevated. In order to see inflation assets really perk back up, we would probably need to see stronger signs that higher inflation may be persistent. To get a read on that, it may be better to look at prices that tend to be more stable. We know there are areas where we’re seeing extreme price moves, which is impacting broader measures of inflation. But what about prices that tend not to move? There is such a measure, developed by the Federal Reserve Bank of Atlanta, called sticky core inflation.

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