MARKET COMMENTARY

Markets tripped slightly this week as rising prices stoked fears that inflation could soon weigh on economic growth in 2022. The Labor Department reported that consumer prices jumped 6.20% in October, a 31-year high for the CPI Index. To make matters worse, the Labor Department also reported the highest number of job openings on record with businesses desperately struggling to find workers, exacerbating the larger supply chain issues. The news sparked a mild sell-off in the equity and bond markets for the week. Bond investors saw the value of their bonds fall, pushing the yield on the 10-year Treasury to its largest increase in a year. With investors glued to the inflation figures, not a lot of attention was paid to the $1 trillion bipartisan infrastructure deal passed late last week. The bill includes funding for transportation, utilities and broadband. The funding is expected to not only upgrade the nation’s infrastructure but also help ease supply chain bottlenecks that have driven much of the increase in prices for U.S. households. That relief is still someway off, however, allowing inflation and labor concerns to dominate investors’ chatter and trimming -0.63% off the Dow Jones Industrial Average by the week’s close.      

Temperatures may be falling, but prices continue to heat up on consumers. Strong consumer demand, lingering Covid-induced supply chain constraints, and labor shortages have collided to brew a perfect storm for higher prices. The CPI Index rose 6.20% YOY in October—the fifth straight month of inflation above 5.00%. The core consumer price index, which excludes volatile categories of food and energy rose 4.60% year-over-year (yoy). That was higher than September’s 4.00% increase and the largest rise since 1991. The acceleration in prices was also seen on a month-to-month basis, giving us a better look at the current trajectory. Prices were up 0.90% in October, indicating an acceleration from the 0.40% in September. If you’ve gone shopping recently, you won’t be surprised to see prices are up everywhere. New and used autos, gasoline and other energy costs, furniture, rent and medical care all rose during the month. Food, a staple of our household budgets, rose by the most in decades. If those price increases are too much to handle, you could always pour yourself a drink, since alcohol experienced a price decline during the month. Tuesday’s October PPI report was in a word – worse. The overall index rose 8.6% from a year ago while the index less food and energy rose 6.2%. There is no question that the types of price increases seen in October’s reports will have policy makers paying greater attention given the laissez faire stance thus far. 

As the producer to the world, China’s factories have been pushed to their brink as we approach the holiday season, straining to meet demand amid Covid disruptions, higher production costs, and labor shortages. Despite the challenges, China’s exports rose 27% yoy in October. That was consistent with September’s 28% increase. China’s own domestic demand was also relatively strong, rising 21% yoy despite China’s continued zero-tolerance, Covid containment strategy which has been in place for most of the year to squash outbreaks. As we enter 2022, China’s exports are likely to slow as strong holiday demand eases but with the considerable global backlog and as more of the world’s economies continue to emerge from the pandemic, China should still be in a strong position for some time.  

 

This week’s inflation reports suggest we are reaching an inflection point. We’ve been talking about inflation for some time now, but most of the higher prices we’ve been noting had been a function of year over year anomalies when comparing current prices, which had normalized, against previous deflationary months. The pop looked alarming in many cases (i.e. gasoline) because you were essentially measuring from a price trough to a price peak. Since the recession ended in April of 2020 through September 2021, consumer prices rose about 7% cumulatively or about 4.3% annualized. This is high historically but not stratospheric. Helping the perception of its affordability, and hence the lack of overall concern on the part of the markets, was the fact that coming out of the recession individuals had accumulated a great deal of savings (either through less overall spending during the pandemic or through the receipt of government stimulus). Wages also started to rise in tandem with prices starting in July of 2020 (for production/non-supervisory individuals, who presumably are among the most susceptible to inflation’s impact). Further tamping down inflationary concerns was the fact that there were specific things one could point to as the source of price increases, most notably a demand shock from consumers emerging from the pandemic along with supply chain problems globally from those regions still impacted by Covid. As long as those items were deemed fixable and temporary, the market remained unphased. October’s report represents a shift. It showed that not only is the annualized inflation rate since the recession closer to 5.00%, which is sort of a psychological level, it is now accelerating at a rate that is 2-3% higher than wage growth. People are starting to really feel the impact of inflation because their wages are not keeping up. We will just have to wait to see whether this is a one month anomaly or a trend, but with the labor market as tight as it is, the stakes with respect to the Fed’s response are rising – and neither of their options are particularly good for markets. Higher inflation may very well still be a temporary phenomenon, just as the Fed believes, but this week’s report certainly puts them in the crosshairs because the market is going to soon want to hear what they plan to do about it.