US Gets Inflation Heat Check As Fed Goes Quiet

Traders and investors will enjoy a break from top-tier US data in the new week with one notable exception: CPI.

Inflation data for May is due Friday, and it’ll land in a void with the Fed in its pre-meeting communications quiet period.

Needless to say, an overshoot versus consensus would be an unwelcome development, especially given the proximity of the June FOMC meeting.

Not that a consensus report would count as “good” either. Indeed, economists expect another 8%+ 12-month print on the headline gauge and a 5.9% YoY gain on core (figure below).

Forgive me, but the optics are still terrible. For policymakers, yes, but for the White House too.

Gas prices hit multiple new records last month (on a nominal basis, at least), the war in Ukraine continues to pose upside risks for food prices and shelter costs are still responding to the US property boom on the usual lag.

Those trends may mean relief on critical monthly readings remains elusive (figure below).

Fed officials including Lael Brainard and Loretta Mester are keen to see the MoM prints decline before countenancing any sort of conciliatory rhetoric on the rates path.

As for the headline-core distinction, BMO’s Ian Lyngen and Ben Jeffery noted that “Brainard’s recent emphasis on the importance of core consumer prices in driving Fed policy hinted of a ‘back to the basics’ moment for official commentary, even if the politicization of inflation has come to define this cycle and left the emphasis on headline prices, in particular gasoline and food costs.”

The political pressure they mentioned is acute. Irrespective of whether the market is inclined to take solace in slightly cooler YoY core prints, national media outlets will run with the headline numbers, as will Republicans seeking an edge headed into the midterms.

You can hardly blame them. Just like you can’t blame consumers for shaking their heads incredulously at the notion that households should be comforted by anything other than a rapid and material decline in the price of food, fuel and housing. No such decline is forthcoming.

I’m compelled to reference the familiar figure (below) as a visual reminder of the “K-shaped” inflation dynamic.

For lower-income cohorts, inflation is usually an “insult to injury” sort of deal. You have less money in general, which is bad enough, but on top of that, your expenditures tend to skew more heavily towards the goods and services for which prices are rising the fastest, compared to those with more income.

Joe Biden last week sought to make it clear that inflation is the Fed’s responsibility, not his. Of course, maximum sustainable employment is the Fed’s job too, but presidents and politicians don’t have any qualms about taking credit for job gains and falling unemployment rates. I haven’t seen any Op-Eds from the White House thanking Jerome Powell and market-timer extraordinaire Richard Clarida for the near total recovery of the jobs lost to the pandemic.

Speaking of jobs, last week’s hot NFP headline suggested the labor market isn’t on the brink of rolling over, and JOLTS data released a few days previous showed there’s been little, if any, progress on closing the gap between openings and workers willing to fill them. Layoffs dropped to a record low in April.

Many market observers pointed to the drop in openings (in the JOLTS numbers), an uptick in the participation rate for May, an unchanged unemployment rate (versus expectations for a small decline) and a slightly cooler-than-expected MoM read on average hourly earnings as evidence that the tide is starting to turn. But all of that’s akin to squinting at a small drop in YoY core CPI and calling it evidence of “peak inflation.”

More importantly, that kind of analysis is at odds with Powell’s exhortation: “This is not a time for tremendous nuance.” He was referring specifically to inflation, but you could apply the same disclaimer to the labor market data. Anyone making claims about Fed “pauses” or “signs of normalization” needs to cite unequivocal, material supporting evidence. Incremental “progress” doesn’t count right now.

At the very least, we’re compelled to say that absent some terrifying turn in the standoff between Vladimir Putin and the West (i.e., some escalation that triggers an across-the-board flight to USD cash like that which unfolded in March of 2020), nothing is going to dissuade the Fed from hiking rates 50bps at the next two meetings. “The May [jobs] report support[ed] the view that while the labor market remains firm, it continues to gradually slow [but] we [don’t] think it changes the calculation for the Fed, supporting their inclination to front-load rate hikes until it reaches a more neutral stance by the fall,” TD’s Oscar Munoz and Priya Misra said.

This week’s auctions will be eyed in the context of Fed balance sheet rundown, but the QT story is really for another day. “While much of the initial ‘stock effect’ may be priced in, markets could react to the ‘flow effect’ as the market needs to attract new buyers,” TD’s Misra and Gennadiy Goldberg wrote, in a separate note. “Given that the impact of QT may well be nonlinear, the start of QT may not be particularly meaningful as reserves remain ample and there is sufficient liquidity in the system.”

Ultimately, the near-term price action in rates and equities will continue to be a manifestation of the good news-bad news tradeoff vis-à-vis perceptions of Fed inclinations to incremental hawkish escalations.

Also on deck this week: The June ECB meeting, at which Christine Lagarde will announce the end of net asset purchases and refine the messaging around an expected July rate hike. The only other notable in the US is the preliminary read on University of Michigan sentiment for June which, to the extent there’s evidence of improvement, will be amenable to the same skeptical treatment as “evidence” of slower inflation.