Here to stay
Producer prices are a precursor to consumer prices (aka inflation) as producers typically experience those higher costs first, and then pass them onto their customers. We had seen producer prices (as measured by the PPI) increase due to supply chain issues well before we saw inflation really take off. Unfortunately for us, producer prices continued to increase in May by 0.8%, bringing the annual increase in prices to 10.8%, which is close to the 11.5% record we saw in March this year.
Moral of the story: Inflation is not slowing down anytime soon. This level of inflation, persisting for a long time, is a world many of us have just never experienced, buckle in for quite the education.
How far will we go?
Consumer spending accounts for two-thirds of our economic growth, so retail sales are a closely-watched indicator for our economy. Retail sales fell 0.3% in May, compared to the 0.1% increase that economists were expecting. On an annual basis, retail sales were up 8.1% but these figures are not adjusted for inflation – so the ~8% higher prices basically drove most of that gain.
Moral of the story: Consumers had really bolstered their savings during the pandemic, and they’re using those savings to make up for the rising costs. But, we’ve kind of spent through those savings at this point and are returning to utilizing credit to fund our spending. Consumer strength has returned to pre-COVID levels, the question is how much will credit spending increase in the face of a looming recession, when consumers tend to shift more into “saving for a rainy day” mode.
Markets had been waiting for this week’s Fed meeting and policy decision. While we knew the central bank was going to raise interest rates, the question was just how much they were going to raise interest rates. The closer we got to the meeting, the more aggressive the market expectations became. The Fed kind of delivered that aggressive decision with a 0.75% rise in interest rates, which is the biggest rake hike since 1994, and bringing the policy rate to 1.5-1.75%. Expectations are for this policy rate to reach 3.4% by the end of the year.
Moral of the story: The Fed is racing against the clock trying to bring inflation lower, and is likely to continue raising rates aggressively until they see a string of data demonstrating that inflation is being brought under control. The issue is that a big part of inflation today is being driven by higher food and energy prices, which are being impacted by what’s happening in Ukraine, and completely out of the Fed’s control. Raising rates basically tempers demand, but the reason for higher energy and food prices is really a supply side issue. If the Fed moves too aggressively to temper demand, we’re going to run head-first into a recession. This impending recession is what’s been causing stocks to slowly slide over the last eight weeks.