Food & Energy Drive INFLATION Higher
Food and energy prices continue to drive inflation higher. According to the AAA motor club, the average price of gasoline hit $5 a gallon for the first time in history over the weekend. According to The Financial Times, gasoline price has risen by more than two-thirds in the past year and has more than doubled since Joe Biden entered office. Rising energy prices have fueled a large part of rising inflation, which accelerated once again in May. The latest consumer price index (CPI) released on Friday showed prices rising 1% in May and 8.6% over the past year. The report showed that food, energy, and shelter prices led to higher inflation. Food prices have risen by 10.1% and energy prices by 34.6% over the last 12 months, according to the US Bureau of Labor Statistics. Core CPI, which excludes food and energy prices, rose by 6% year over year. Persistent evidence of inflation raised fears for investors that the Federal Reserve will be more aggressive in raising rates to slow down economic growth.
US Equities Drop After Strong Jobs Report
US equities dropped last week following a stronger than expected May jobs report. The equity market has now declined in eight of the past nine weeks. The US labor market remains strong as the Department of Labor reported strong hiring for May. Although the
payroll data came in lower than the previous month, job growth was stronger than expected. The strong jobs data was negative for the markets as investors anticipate that the Fed will be inclined to be aggressive in raising interest rates. The Fed has already lifted the central bank’s main rate by 0.75 percentage points this year and is expected to follow up with further aggressive tightening. An excessively strong jobs market is inflationary, and the Fed is keen to slow job growth.
Equities to Bear Market Territory
Equities fell into bear market territory, more than 20% off its most recent high on Friday, before recovering before the close. Equity markets recorded another week of negative returns, with the S&P 500 and the Nasdaq losing streak reaching eight consecutive weeks. Continuing worries over economic growth and inflation sent investors away from the equities market. Disappointing earnings from major retailers such as Walmart showed the negative effects of inflation on corporate earnings. Crude oil prices rose to $112 a barrel, and the average price of gasoline reached new record highs. The Conference Board’s Measure of CEO Confidence fell for the fourth straight quarter. The survey showed that CEOs expect inflation to normalize sometime in the future and expect the Fed’s interest rate hikes to cause a brief recession. Investors bought into safe haven assets, sending the 10-year US Treasury note yield lower to finish the week below 2.8%.
Bitcoin Trading at Half All-time High
Cryptocurrencies surged in price during the pandemic. The first cryptocurrency and the most popular, Bitcoin hit an all-time high of over $60,000 just last November. With a sell-off that has accelerated in recent weeks, Bitcoin is now trading at less than half of its all-time high. Cryptocurrencies have been caught up in the sell-off affecting broader markets. The fear that the Fed will need to be aggressive in raising rates to bring in inflation has caused risky assets to fall, including equities and cryptocurrencies. Advocates saw Bitcoin as an inflation hedge. As inflation soared, so would the price of Bitcoin. But there is little data to suggest that as Bitcoin was only created over a decade ago. The outlook for cryptocurrencies will continue to be tied to broader market sentiment. Dramatic falls in the prices of cryptocurrencies might also alarm policymakers, leading to more regulation
Non-farm Payrolls Exceed Forecasts
The US labor market shows strength as non-farm payrolls grew more than 400,000 in April, exceeding forecasts. The unemployment rate stayed at 3.6%, close to the level before the pandemic began. Job growth was widespread, with the leisure and hospitality sector recording a large portion of the gain. Manufacturing, retail, and transportation sectors also added jobs. Job creation has been running very strong over the past year, and the unemployment rate has fallen more rapidly than economists expected. Employers’ struggle to fill positions has caused wages to rise. Although positive for the consumer, wage gains are negative for the inflation outlook and the Fed. Average hourly earnings in April climbed at an annual rate of 5.5%.
Record Trade Deficit Contracts Economy
The Commerce Department reported that the U.S. economy contracted by 1.4% in the first quarter, way below expectations. A record trade deficit was mainly to blame as consumer spending remained strong. Other economic data such as capital goods orders and personal spending showed continued expansion. The 10-year U.S. Treasury yield ended the week unchanged at 2.94%, but there was underlying volatility as the yield reached the low of 2.72% earlier in the week before rising.
Hawkish Comments Cause Selloff
Equities fell again last week for the third consecutive week. The fear of a more aggressive Federal Reserve raising rates to tame inflation caused investors to sell. Hawkish comments from Fed chair Powell on Thursday caused rates to go higher, causing the selloff in the equity markets to accelerate towards the end of the week. Technology and communication services sectors lagged as value performed better than growth. On the strength of the U.S. economy, we received mixed data. The Purchasing manager’s index (PMI) showed expansion, but the services PMI dropped from the previous month but also showed expansion. The 10-year Treasury rose to a three-year high at just under 3%.
May Interest Rate Hike Likely
With U.S. inflation at a forty-year high, the Federal Reserve is pressured to be aggressive in reducing monetary accommodation by raising rates. The robust U.S. labor market, reflective of a strong economy, gives the Fed the ability to be aggressive in raising rates. Initial jobless claims two weeks ago came in at the lowest level since the late 1960s. Last week, initial claims did rise some, but it remains near a half-century low. The labor market’s strength considering the economic consequences of Russia’s war against Ukraine and companies facing multi-decade high producers price index is striking. The likelihood that the Fed will raise interest rates in early May by 50bps is high.
Earnings Season Picks Up
This week, earnings season picks up with some of the largest financial firms reporting, such as Goldman Sachs, Wells Fargo, BlackRock, Citigroup, and JPMorgan Chase. On the economic front, the Consumer Price Index (CPI) and Producer Price Index (PPI) will be released on Tuesday and Wednesday, which all investors will be paying close attention to. CPI is expected to increase from the previous month as costs of goods and services continue to rise. Retail sales data and the University of Michigan’s preliminary reading of its Consumer sentiment Index for April will be released on Thursday. The preliminary reading of the Consumer sentiment index will provide insight into inflation’s effect on consumers. Consumer sentiment has been at a multi-year low. Retail sales have held strong over recent months despite rising prices.
Strong Job Growth for March
The Bureau of Labor Statistics report showed strong jobs growth in March as higher wages encouraged workers back to the labor force. Noticeable job gains were in the leisure and hospitality sectors, which was encouraging. For the first quarter of 2022, job growth averaged north of half a million per month, according to FT.com. The unemployment rate dropped to 3.6%, the lowest level since before the pandemic. The lower unemployment gives the Federal Reserve another data point supporting a more aggressive monetary policy to tame inflation. Strong labor data caused a further sell-off in short-dated U.S. government debt, causing further flattening of the yield curve.