Mar ’20 Trend Line Breached Intra-Week Last Week But Saved By Close, Matter Of Time Before S&P 500 Joins Nasdaq 100

The current debate is not about if inflation is percolating, rather if the expected increase is transitory or persistent. The Fed believes it is the former. Speaking the same morning post-CPI report, Vice-Chair Richard Clarida said he was “surprised” by the jump in inflation but stressed that this would prove transitory.

The long end of the Treasury yield curve is rallying, with the 10 year (1.64 percent) having bottomed at 0.4 percent in March last year and ticked 1.77 percent on March 30 this year. But two-year yields, which tend to be the most sensitive to interest rate policy, are well anchored at 0.15 percent to 0.16 percent. This is giving the Fed leeway.

Markets have upped their inflation expectations but even here they expect pricing pressure to moderate in outer years.

The University of Michigan’s preliminary reading for May showed survey respondents expect inflation to rise 4.6 percent next year and 3.1 percent in the next five years, for a spread of 1.5 percentage points (Chart 3). As recently as last December, the spread was zero, with expected inflation of 2.5 percent for both periods.

Despite the recent uptrend, once again, the message is that inflation is rising but contained.

The macro picture has taken a sharp turn higher from Covid-spurred depressed levels. The first estimate showed real GDP grew 6.4 percent in the first quarter, coming on the heels of 4.3 percent increase in 4Q20 and a 33.4 percent jump in 3Q. Before that, the economy contracted 31.4 percent in 2Q and five percent in 1Q.

There is plenty of liquidity sloshing around in the system – both fiscal and stimulus – with the former in particular giving a nice jolt to economic activity post-pandemic. In April, retail sales were essentially unchanged month-over-month to a seasonally adjusted annual rate of $619.9 billion – a new record – but surged 51.2 percent year-over-year (Chart 4). No one believes this pace is sustainable. This lends credence to inflation doves’ argument that we are not headed for a repeat of how things evolved in the ’70s.

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