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NEW YORK, NEW YORK – MARCH 10: A person shops for groceries at Lincoln Market on March 10, 2022 in … [+] the Prospect Lefferts Garden neighborhood of Brooklyn borough in New York City.The Labor Department reported that consumer inflation rose 7.9% over the past year, the largest rise since 1982, raising the prices of gas and consumer goods. Grocery costs rose to 8.6%, the biggest year-over-year increase since 1981, and gas prices increased 38% all within a 12 month period ending in February. (Photo by Michael M. Santiago/Getty Images)
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It is familiar reading. The U.S. inflation rate once again hit a 40-year high in March at 8.5% as energy and food prices surged. The monthly increases in prices was the highest since this inflation spike began, as impacts from the Ukraine conflict further disrupted commodity pricing and supply chains. Bond markets are taking this prolonged bout of inflation, and the Fed’s potential reaction to it, even more seriously as the yield on the 10-year Treasury now stands at approximately 2.7% a sharp increase compared to 1.7% just a month ago.
Though many are discussing whether this is the peak level of inflation, the bigger question for markets is where inflation will settle over the next few years. That will have implications for both stock and bond pricing, and of course the Fed’s path for interest rates.
Certain cost increases may have been one-off spikes, and though they may not necessarily reverse, will not push up inflation further if prices continue to level off or even fall back. We may be seeing this trend in used cars and trucks, which are up over 30% year-on-year, but now prices are starting to decline from potentially peak levels. However, there are counter examples too, for example, airline fares have been rising and continued to rise strongly in the March CPI data as travel demand surges.
Housing
Key clues for longer term inflation include the cost of housing. This makes up a large proportion of the inflation index since housing costs are such a large proportion of household budgets. Unfortunately price increases in housing appear to be accelerating in the official CPI data with the March release. Housing continues to be a puzzle as CPI rates for prices increases are well below other sources that track house prices such as Case-Shiller and Zillow indices. Maybe now the CPI estimate of housing costs is catching up to other metrics.
Services
Price increases for services may provide a clue to medium-term inflation as well. Price spikes in many goods have been driven by commodity spikes and supply chain issues, services are somewhat more insulated from these trends. Unfortunately, again the outlook from the recent data is concerning. Prices of services which had been rising at a lower rate are increasing faster in the March inflation report.
Still compared to the headline rate of 8.5% services and housing are both seeing prices rise at a slower annual rate of 5.1% and 6.4% respectively. That’s still far higher than the Fed would like, given their 2% inflation target, but somewhat more promising for the medium-term inflation outlook than headline figures suggest.
So beyond the headline figures there is some comfort from certain core categories rising at a lower rate. This may become more apparent as we start to lap certain commodity price surges later this year. However, the worry is that housing and services may now be seeing their own inflation increases, and that doesn’t bode well for medium-term inflation. That’s one reason why the Fed plans to raise rates aggressively this year, prompting nervousness in both stock and bond markets. Markets are starting to look past what may be peak inflation, but the picture may still not be a positive one.
Financial Services
