Yesterday, I warned that the market would tank if inflation wasn’t lower by more than a few tenths of a percent.
**U.S. Inflation Hit 8.6% in May**
**Energy, groceries, shelter costs drive fastest rise in consumer-price index since December 1981**
**By Gwynn Guilford, The Wall Street Journal, June 10, 2022**
**...**
**May’s increase was driven in part by sharp rises in the prices for energy, which rose 34.6% from a year earlier, and groceries, which jumped 11.9% on the year, the biggest increase since 1979. But inflation pressures were distinctly broad-based in May...**
**Price pressures are strong across much of the economy in part because of an unusually tight U.S. labor market, with demand for workers outstripping supply....Those dynamics are driving wage growth, adding to inflationary pressures. Strong gains in wages and hiring are pumping more money into Americans’ bank accounts, propping up demand as inflation erodes spending power for many. Meanwhile, higher labor costs stemming from worker shortages are prompting many employers to raise prices....** [end quote]
That is a classic wage-price inflationary spiral which was endemic to the 1970s. If this goes on much longer, inflationary expectations will become “entrenched” as they were in the 1970s. That is, consumers and workers will plan ahead. Consumers will buy earlier than they might have otherwise to avoid rising prices. Workers will demand higher wages in anticipation of higher prices, further driving inflation.
The Federal Reserve is only too aware of this dynamic.
https://wellsfargo.bluematrix.com/links2/html/041e3c66-0103-…
**Wells Fargo Economics, June 10, 2022**
**by Sarah House and Michael Pugliese**
**CPI: Worst Still to Come**
**...**
**Simply put, inflation remains far too high for the Federal Reserve's liking. Until inflation is demonstrably on the downswing, we expect the FOMC to fight back aggressively with tighter policy. Another 50 bps rate hike is all but assured at next week's FOMC meeting, and a couple more 50 bps hikes in July and September seem highly likely....**
**Across the Board Pain**
**The "clear and consistent" progress Fed officials are looking for on inflation remains elusive. The Consumer Price Index rose 1.0% in May, pushing the year-over-year rate to a fresh high of 8.6%. What's more, the worst prints are yet to come by our estimations. We suspect that the formidable momentum in inflation could push the headline rate for CPI close to 9% as early as next month. If that's not bad enough for consumers and the Fed, CPI inflation is likely to stay near those levels through the autumn....** [end quote]
I think that economic writers are being too timid when they predict a few more 0.5% raises in the fed funds rate. The yield curve shows a 2-year T-bill of 2.8% and rising fast. I think this is too timid.
The Fed wants a “neutral” fed funds rate. Anything less than the inflation rate is a negative real yield!
https://stockcharts.com/freecharts/candleglance.html?$IRX,$U…
Inflation momentum is building. The only way to stop it is sharp rises in the fed funds rate and longer-term bond yields (which the Fed can do by selling its huge book of Treasury and mortgage bonds).
That would drain excess liquidity out of the system. All asset prices would fall as a result – stocks, bonds, real estate, etc.
Consumer prices will stabilize when consumers have less money to spend and suppliers bring more goods and services to the market. Some supply chain restrictions are finally loosening but the war in Ukraine is ongoing.
As an investor, I am keeping my powder dry. I am holding my cash in short-term (3 to 6 month T-bills bought from TreasuryDirect.gov), not in bonds whose value will fall as interest rates rise.
This is no time to be buying stocks since the market is headed down. Follow the “mungofitch 99 day rule.” Don’t buy stocks until the SPX has made new highs for 99 trading days. The 1970s had several “bear traps” – market bounces that failed – which would be avoided by the 99-day rule.
As a consumer, I’m keeping my eyes open for sales forced by inventory overstocks. The supply chain blockages (e.g. in the port of Los Angeles) are finally loosening but many of the goods were seasonal (e.g. patio furniture which is usually bought in early spring). Out-of-season sales will probably be good for the consumer but bad for retailers.
We are back to the future in the 1970s now. METARs who lived through it know the drill.
https://www.youtube.com/watch?v=i0MzvQhl23U
Wendy
