The Week Behind

The major indices slept Monday through Wednesday only to fall out of bed midday Thursday and continue falling into Friday. About halfway through Thursday’s session, the selling started as investors decided the risk-reward was skewed against them. Friday’s 8.6% Headline vindicated Thursday’s action and begot more selling, which petered out around noon. Major indices would close near those intraday lows. 

Highlights:

• Consumer Credit revealed a rise of $38.1B versus the consensus $35B. 
• Headline CPI came in at 8.6%; Core CPI came in at 6.0%.  
• Oil broke out to $120 – Brent and WTI.
• The US 10-Year Treasury (US10YR) broke and sustained 3.0%.
• Overnight (Thursday into Friday), the US 2-Year Treasury (US2YR) moved ~9.5% from 2.8% to 3%.

For the week, the DOW and S&P fell 4.96% and 5.66%, respectively. The NASDAQ, the most interest-rate sensitive, fell 7.05% as the US10YR spiked to 3.178%. The US10YR closed the week near the highs at 3.165%. Adding to the pressure, the US2YR spiked from 2.8% to 3.07%, on Friday soon after CPI released.  

The Peak Inflation Debate

While May Core CPI came in at 6%, notching another month-over-month (MoM) decrease from 6.2% in April, May Headline reached 8.6%, breaking the previous high of 8.5% reported in March. In my view, despite another consecutive MoM decrease in Core, this data puts an end to the notion inflation had peaked. 

Outside of shelter and airline fares, those hoping for cooler CPI reports have little to hang their hats on. I think shelter data has yet to reflect lower housing costs as higher interest rates gradually lower demand. Airline fares increased 12.6% in May, following a 18.6% increase in the prior month. I think fares will naturally come down as the current vacation season concludes. 

Core ignores energy and food; whereas, Headline factors them in. The growing spread and uncorrelated trend between Core and Headline showcase the growing magnitude of energy and food inflation. The former exacerbates the latter via petcoke: an oil byproduct essential to fertilizer. Energy is up 34.6% and gasoline is up 48.7% over the trailing twelve months (TTM). Until we see a change in U.S. energy policy or an end to conflict between Russia and Ukraine, both double as major food-producing countries, I do not see any catalysts to meaningfully dampen energy or food inflation beyond an intentionally-caused FED recession. 

To quickly summarize the relation between a recession and energy/food inflation, a recession represents decreased demand across many, if not all, economic sectors. This would decrease trade volume and the overall amount of goods/services sold in an economy. Given oil is essential to all gasoline-dependent trade and an input for a plethora of everyday products, demand for oil would also decrease, bringing down the price. Furthermore, cheaper oil means cheaper fertilizer means cheaper food.   

If oil sustains ~$120/barrel, above May’s average, I hypothesize June’s CPI will feature an even hotter Headline. However, if airline fares normalize and the effects of interest rates begin to show in shelter data, we could see Core continue to cool. 

The Week Ahead

It is FED Week. Monday, Vice Chair Brainard is scheduled to speak at 2PM. Tuesday, we get PPI, a leading indicator for CPI. Our main event is 2PM on Wednesday as the next hike will be made official via the FOMC meeting. Powell is scheduled to speak on Friday morning, 8:45AM. 

While I think the market would welcome more aggressive FED action in the aftermath of CPI, I do not expect the FED to deviate from 50bps. Based on the FED’s messaging, I think they’ll focus on Core CPI and PCE because these metrics better reflect inflation that can be tackled via QT. Core continued to move in the right direction and, PCE, the FED’s preferred indicator, is not due until June 30th. Short of causing a recession, the FED cannot affect food and energy inflation. However, given their particularly damaging and sticky nature, the FED could decide it’s bad enough to warrant a recession and intentionally overtighten. More likely, this hot print guarantees 50bps in September. 

On a more optimistic note, Friday’s CPI provided all the reason necessary for a retest of the lows, but the market did not take the opportunity. The S&P500 continued its persistent refusal to close below 3,900 even when crossing below it. Based on the nature of Friday’s sell-off, I think the bad CPI print is priced-in. Consequently, barring any material news in the interim, I think prices on Wednesday will look similar to prices on Monday. From there, depending on the outcome, we’ll either retest the lows or begin to stabilize.  

Circling Back     

For any that read the previous brief, here is a follow-up on the earnings prints referenced:

• Dave and Buster’s (PLAY) reported a beat on the top and bottom lines, providing additional evidence consumer demand is not declining as much as it is shifting towards experience and services.
• Campbell (CPB) reported a beat and raised guidance citing strong demand, robust supply chain, and a reduction in marketing expenses to cushion margins.
• DocuSign (DOCU) reported a topline beat and bottomline miss. Given DOCU is a technology-enabled company, who’s strength should lay in cost-efficiency, a bottomline miss in conjunction with a topline beat is a major cause for concern. Following the report and multiple downgrades, that concern manifested itself in a 25% decline.