Inflation Backlash

Investment Insights: Market Update


  • Financial market sentiment has soured after a higher-than-expected inflation reading and an expected pivot from the Federal Reserve.
  • Investors have shifted their expectations for rate hikes higher with predictions now reflecting the fed funds rate reaching 3.7 percent by year-end.
  • Positive factors may be difficult to see due to recent headlines, but remain supportive for financial markets and the economy over the near-term.
  • An eventual economic downturn may be on the horizon, but is very unlikely to occur this year.

After an unexpected result in economic data last week, the mood in the financial markets has soured—to say the least. On Friday, the May release for the Consumer Price Index showed inflation rose more than expected from the month prior, and also on a year-over-year basis, reflecting an 8.6 percent increase in prices since the same time last year. The consensus estimate for May's year-over-year inflation was 8.3 percent. Markets reacted to the news accordingly, with the S&P 500 Index falling almost 3 percent and bonds declining as well. Investor sentiment remained negative into the weekend as overseas markets weakened. Selling accelerated today with shares declining 3.9 percent. Within the S&P 500 Index, energy, real estate, and consumer discretionary sectors—which are cyclical and heavily related to the consumer—saw the largest declines.

The May price reading is showing investors that inflation still hasn't peaked, as some had speculated. Not only that, the surprise increase may also validate warnings from the World Bank and other organizations that a period of stagflation—a time of abnormally high inflation and below-trend growth—could be on the horizon. Most importantly for investors, the new data will also affect the Federal Reserve, which may take an even more hawkish pivot at its rate meeting on Wednesday. Currently, markets are still pricing in a 0.50 percent hike at the Fed's June 15 meeting, with a lower chance of a 0.75 percent increase. However, expectations have shifted for rates. Fed funds futures are now showing that investors see the key overnight rate reaching 3.7 percent by the end of the year—notably higher than the 2.8 percent forecast just a few weeks ago. These expectations have driven a repricing in bond markets as well, with government bond yields shifting across the curve. The benchmark 10-year Treasury yield climbed to 3.4 percent today as broad US bond markets correspondingly decline.

While the recent news and sentiment have been negative, much of the market response seems to be an overreaction and a repricing for a more hawkish Fed. However, it's unlikely that Fed officials will allow one inflation print to meaningfully alter the rate guidance they have spent months laying out and broadcasting. Despite the surprise jump, officials will likely continue to closely monitor consumer prices to see if the trend is truly accelerating, or if this may have been a short-term blip. Additionally, economists are still forecasting positive consumer spending numbers—a key driver for the US economy—to actually increase this quarter and remain strong through the rest of the year. Despite some negative sentiment, the consumer is generally still financially well-positioned, with household net worth holding near peak levels. Lastly, for stocks, Wall Street analysts are forecasting 10.4 percent growth in earnings for 2022—a strong support for higher prices going forward.

It may be difficult to see with so many unpleasant financial market headlines, but there are still many positive factors for investors that should provide support for financial assets in the near-term. Talk of a recession continues to be one of the largest worries for many. Slowing growth to below-average levels, or even an eventual downturn, could be on the horizon—but that is not happening right now. Or even this year by most estimates. While first quarter GDP was -1.5 percent, the US economy is still expected to grow by 2.6 percent in 2022. We continue to advocate for a disciplined investment approach, one that focuses on long-term goals and maintaining diversified portfolios.

Market Dashboard

After an unexpected result in economic data last week, the mood in the financial markets has soured—to say the least.

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[Contributors Section]
Cyrus Charna
Investment Strategy Officer
Ben Baier
Lead Investment Officer
Wade Balliet, CFA
Chief Investment Adviser