The inflation debate continued during the week, with sentiment siding with the transitory view, if the bond and equity markets are any indication. The 10-year treasury rate fell to its lowest level in three months, helping push tech stocks higher as the implied discount on future earnings lowered with rates. Financials came under pressure as falling rates tend to reduce margins. Except for the more concentrated Dow Jones index, equity markets rallied, with the S&P 500 hitting a record high during the week. The TSX gained 59 basis points, the Dow lost 80 basis points, the S&P gained 41 basis points, Nasdaq gained 1.85%, and the Russell 2000 gained 1.75%.
The big economic story of the week was the US Bureau of Statistics reporting CPI increased 0.6% in May after an 0.8 increase in April. Over the last year, inflation reached 5%, the highest level in 13 years. The inflation rate is trending higher since January when the one-year inflation rate was 1.4%. One of the key drivers in May was used car prices, contributing to one-third of the increase. Inflation ex-food and energy also jumped 0.7% in May after an increase of 0.9% in April. The one-year inflation rate ex-food and energy is 3.8%, the highest level since 1992. Over the last 12 months, the energy index rose 28.5% and the food index by 2.2%.1 The Fed response was assurances that they continued to believe the spike in inflation was temporary and they would keep the rate low for some time.
On Tuesday, the US Bureau of Statistics reported the number of job openings reached a high of 9.3 million on the last day of April. As expected, the most significant increase in job availability was in the accommodation and food service (349,000) and other services (115,000). Durable manufacturing was short 78,000 workers while job openings decreased in educational services (-23,000) and mining and logging (-8,000). Last April, at the peak of the pandemic, there were 4.6 unemployed workers available for each job opening. In February, that number had dropped to 1.35, March 1.19, and most recent April 1.06.2
Total separations, including those quitting, layoffs and discharges, and other separations, increased to 5.8 million. The quit rate is viewed generally as workers’ willingness to leave a job. In April, the quit rate reached an all-time high of 4.0 million, with retail showing the largest increase (106,000), followed by professional and business services (94,000), and transportation, warehousing and utilities (49,000).3
As mentioned in the past commentary, small businesses continue to have difficulty finding workers to fill vacancies. Federal government supplemental benefits on top of state benefits make it possible for low-income workers to stay at home. Worries of health safety, childcare, and skill mismatch also contribute to workers’ reluctance to return to work.4 Twenty-three states have decided to phase out federal unemployment assistance programs to encourage workers to return to the labor market.5 To entice workers, employers are offering hiring bonuses, increased wages, and additional benefits like healthcare.
Market reaction to inflationary data suggests investors are becoming complacent and accept the central banks’ view of recent inflation as temporary. Central banks have two goals, maintaining loose monetary policy, encouraging spending and economic growth while supporting maximum employment recovery to pre-pandemic levels. Initially, markets reacted negatively to the acceleration of inflation not seen for many years and worry the central bank, while focusing on employment, may wait too long before shifting focus to limiting inflation. The recent strength in corporate earnings, consumer demand, and vaccination rates allowing for re-opening economic activity are over-riding inflationary concerns. As we approach acceptable employment levels, we are likely to see pressure on rates as we did earlier this year, pushing yields off their historic lows and creating nervousness in equity markets. The transition from employment-centric central bank policy to inflation could spark volatility in equities and a potential correction later in the year or the first half of next year.
Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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