Weekly Update

Markets Shrug off Inflation

Tagged: , , , , , , , , , , , , , , , , ,

Published June 11, 2021

This week’s inflation report generated plenty of alarming headlines. As the chart below shows, inflation hit its highest point since, well, the end of the last economic crisis. Which points to one of the reasons why the alarming headlines are misleading. The inflation report is comparing against data from a year ago, a time when the world was essentially shut down with business activity moribund. Consumer prices were exceptionally low then. When compared against those low prices, the jump in prices and inflation readings will appear alarmingly high.

U.S. consumer prices

But the markets have shrugged. Why? They are beginning to buy into the Federal Reserve’s argument that rising inflation will be temporary, that prices will normalize fairly quickly and inflation will peak around the targeted 2%. If you compare prices over a two-year period, back to pre-pandemic levels, inflation is not alarming at all. The chart below shows that consumer prices are range-bound.

Two-year percent change in consumer-price index

The other input calming markets about inflation pressure comes from two of the hottest commodities: lumber and copper. Both appear to have peaked in price a month ago, easing since.

Lumber and Copper

Take these inputs along with the stalling in Congress (and reduction in size) of any additional new stimulus/spending, and you get markets backing off their fears of ever-rising inflation and an overheating economy.

The most telling response has come from the bond market. Yields on the 10-year Treasury note have stopped rising and now have fallen below the 1.5% level, suggesting that concerns of a tightening Fed are diminishing. The chart tells us this ~1.5% level has been a point of support over the past few years.

Yields on 10-year Treasury note

Interest rates have recovered very quickly, of course. Some pause at this level is not surprising. If it continues, however, the calls for a surge to a 2% 10-year interest rate will quiet.

This pullback in rates should lead to an upward shift for homebuilders. Houses for sale are scarce causing prices to rise sharply. It would seem the stars are aligned for booming home construction. But their shares have slid back, although they are still up sharply year-to-date.

Home Builders

In summary, ignore the alarming inflation headlines. Prices, while elevated, are likely to ease by year-end as supply chains and labor markets normalize. The bond market is telling us so, for now at least.

As an aside, this relaxation in inflation fear has been a near-term positive for our focus Nasdaq 100 (QQQ) index. Rising rates have been their Achilles heel this year. A drop back in rates has lit at least a little fire under the index.

Market Update

Stocks kicked off the week continuing the prior week’s theme of re-embracing growth stocks. The Nasdaq pushed upward Monday by +0.5% while the S&P 500 and Dow Industrials held flat. And again on Tuesday with energy shares showing strength as oil prices continue notching gains. A listless summer session Wednesday with investors awaiting the headline inflation report Thursday. Of note in Wednesday’s trade, the 10-year Treasury yield dipped below 1.5% for the first time in three months. The inflation report Thursday showed a +5% headline rise. But markets reacted positively with stocks moving higher by +0.5% while interest rates tumbled. Investors perhaps read the report feeling that much of the lift in prices came from one-off items that are indeed temporary. Stocks held flat near record levels Friday on little new news.

Stocks moved higher this week with the S&P 500 (SPY) adding +0.4%. The Nasdaq 100 (QQQ) showed improving strength with a +1.68% gain. Smallcaps (IWM) appeared to break out of their months-long sideways trade with a +2.04% break upward.

Warm wishes and until next week.