Inflation Hits 30-Year High
The U.S. consumer price index (CPI) jumped 6.2% in October, leading to the biggest inflation surge in more than 30 years. The core CPI (removing the impact of food and energy) mirrored these numbers, increasing 4.6% to another 30-year high. Either way, you slice these CPI numbers, these increases are screaming decades' high inflation. The sky-rocketing inflation numbers are negating wage increases that workers have been receiving. These data continue to be at odds with policymakers maintaining that the current price pressures are transitory and related to Covid pandemic-specific issues. Albeit they have admitted that inflation has been more persistent than they expected, they see conditions returning to normal over the next year or so.
Escalating inflation could cause the Fed to tighten policy more quickly than it has signaled. The central bank has indicated that it will within the next few weeks start reducing the amount of bonds it buys each month, though officials have indicated that interest rate hikes are still off in the future. These rising inflation expectations and the realization of these inflationary pressures could cause the Federal Reserve to change policy course sooner rather than later. It's going to be a tug-a-war between inflation, employment, Washington wrangling, and the delta variant backdrop. CPI reports will become more significant as these readings are used to identify periods of inflation. The recent CPI readings are resulting in a much stronger influence on the Federal Reserve's monetary policies hence the recent taper guidance.
Unsustainable Inflation
The CPI basket of goods is increasing at unsustainable rates. Fuel oil prices soared 12.3% in October, culminating in a 59% increase over the past year. Energy prices overall rose 4.8% in October and are up 30% for over the past 12-month period. Used vehicle prices continued rising 2.5% on the month and 26% for the year. New vehicle prices were also up 1.4% and 9.8%, respectively. Food prices also showed an uptick of 0.9% and 5.3% respectively. Within the food category, meat, poultry, fish, and eggs collectively rose 1.7% for the month and 11.9% year-over-year. The Federal Reserve will need to heed these real inflation numbers before it wreaks havoc on the consumer and businesses alike.
Earnings Commentary Harbinger
Costco (COST), Federal Express (FDX) and Nike (NKE) have warned that inflation is real and is bound to hit consumers as the holidays approach. Costco, Federal Express and Nike are seeing rising shipping costs and supply chain disruptions that are persisting and should continue through the upcoming holiday season. In particular, the cost to ship containers overseas has skyrocketed over the past few months.
Supply chain disruptions, specifically in the shipping channels have led to rising freight costs that have escalated shipping costs dramatically. The cost to ship containers overseas has soared in recent months. A standard 40-foot container from Shanghai to New York costs about $2,000 a year and a half ago pre-pandemic. Now, it runs some $16,000, per Bank of America.
Costco CFO Richard Galanti called freight costs "permanent inflationary items" and said those increases are combining with things that are "somewhat permanent" to drive up pressure. They include not only freight but also higher labor costs, rising demand for transportation and products, plus shortages in computer chips, oils, and chemicals, and higher commodity prices.
Nike CFO Matthew Friend made references to second-half price increases as well as "stronger than expected full-price realization" and "additional transportation, logistics, and airfreight costs to move inventory in this dynamic environment." "There's only so much you can pass on to the consumer," he said. "What most retailers are doing is looking across their [profit and loss statements], and they're looking to improve performance and to optimize efficiency. That means really focusing on their supply chain."
FedEx announced that it will hike shipping rates by 5.9% for domestic services and 7.9% for other offerings. The company said it is being hit by labor shortages and "costs associated with the challenging operating environment."
"The labor market is tight, and in certain parts of the country, we've had to make some market-rate adjustments to react to the demands of the market," per United Parcel Service (UPS) CEO Carol Tome. UPS has also has been hit by supply chain issues. "I'm afraid this is going to last for a while. These issues have been a long time coming, and it's going to take all of us working together to clear those blockages," Tome said.
The Federal Reserve Inflationary Commentary
The Federal Reserve indicated that the central bank is likely to begin withdrawing some of its stimulatory monetary policies before the end of 2021. Although interest rate hikes are likely off in the distance, the economy has reached a point where it no longer needs as much monetary policy support. This pivot in monetary policy by the Federal Reserve sets the stage for the initial reduction in asset purchases and downstream interest rate hikes. As this pivot unfolds, risk appetite towards equities hangs in the balance. The speed at which rate increases hit the markets will be in part contingent upon inflation, employment, and of course the pandemic backdrop. Inevitably, rates will rise and likely have a negative impact on equities.
A string of robust Consumer Price Index (CPI) readings spooked the markets as a harbinger for the inevitable rise in interest rates. Although rising rates may introduce some systemic risk, the financial cohort is poised to go higher. The confluence of rising rates, post-pandemic economic rebound, financially strong balance sheets, a robust housing market, and the easy passage of annual stress tests will be tailwinds for the big banks.
Future Rates Hikes Coming
Jerome Powell stated, "The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test," He added that while inflation is solidly around the Fed's 2% target rate, "we have much ground to cover to reach maximum employment," which is the second prong of the central bank's dual mandate and necessary before rate hikes happen.
The Fed looks at employment and inflation as benchmarks for when it will start tightening. Powell said that "test has been met" for inflation while there "has also been clear progress toward maximum employment." He said he and his fellow officials agreed at the July Federal Open Market Committee meeting that "it could be appropriate to start reducing the pace of asset purchases this year." The Fed committed to full and inclusive employment even if it meant allowing inflation to run hot for a while.
Consumer Price Index (CPI)
The Consumer Price Index (CPI) readings will become even more important moving forward and have directly impacted market movements and overall sentiment. These CPI reports are becoming more significant as these readings are used to identify periods of inflation. More robust the CPI readings will translate into a stronger influence on the Federal Reserve's monetary policies and downstream interest rate hikes. The Federal Reserve is reaching an inflection point to where they will need to curtail their stimulative easy monetary policies as inflation, unemployment, and overall economy continue to improve. It is inevitable that their long-term monetary policy of low-interest rates and bond purchases will need to pivot to a scenario of higher rates to tame inflation. Investors can expect increased volatility as these critically important CPI reports continue to be released through the remainder of 2021. Additionally, any notion of higher rates may spur investors to reduce exposure to equities.
Conclusion
The CPI jumped 6.2% in October, the biggest inflation surge in more than 30 years. The core CPI increased 4.6% to another 30-year high. These data continue to be at odds with policymakers maintaining that the current price pressures are transitory and related to Covid pandemic-specific issues. Albeit they have admitted that inflation has been more persistent than they expected. Real-world inflation is impacting company earnings reports as witnessed by Costco, Federal Express, and Nike. These companies specifically pointed to supply chain disruptions, labor costs, and shipping costs. The Federal Reserve also said that tapering is now in the cards between now and the end of 2021. It's going to be a tug-a-war between inflation, employment, Washington wrangling, and the delta variant backdrop. CPI reports will become more significant as these readings are used to identify periods of inflation. The recent CPI readings are resulting in a much stronger influence on the Federal Reserve's monetary policies hence the taper guidance.
Investors are speculating on when, not if the Federal Reserve will curtail their stimulative easy monetary as inflation, unemployment, and overall economy continues to improve. It is inevitable that low-interest rates will not be here indefinitely, and bond purchases will need to subside thus pivoting to a scenario of higher rates in the intermediate-term. As investors grapple with the prospect of downstream rate increases, pockets of vulnerabilities throughout the market will be exposed when rate hikes are deemed on the horizon. As real inflation enters the fray, these frothy markets will come under pressure as evidenced by the volatile month of September. This could possibly continue to disrupt the market and introduce some systemic risk in the process. Investors can expect increased volatility as a function of key economic data, specifically the CPI readings and more real inflationary data.
Noah Kiedrowski
INO.com Contributor
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