CPI Readings – The Market’s Blight

Consumer Price Index:

The Consumer Price Index (CPI) has become the most influential and critical variable in today’s market. An important CPI reading will be reported on Wednesday, July 13th which may dictate the market's direction as the second half gets off to a start. The CPI readings directly impact monetary policy put forth by Federal Reserve via interest rate hikes, bond buying and liquidity measures. Inflation continues to be persistent throughout the economy and the Federal Reserve must balance curtailing inflation without destroying the economy. The impact of inflation is now flowing through to companies and consumers alike. Inflation has reared its ugly head and is now negatively impacting companies’ gross margins and dampening consumer demand due to soaring prices, specifically gasoline.

The confluence of rising interest rates, inflation, China Covid lockdowns and the war in Ukraine has resulted in months of selling. The relentless indiscriminate selling has pushed the Dow Jones and S&P 500 deep into correction territory while pushing the Nasdaq deep into a bear market. As such, the market appears to be factoring in a worst-case scenario that may result in a Federal Reserve induced recession as a function of over-tightening on monetary policy and/or its inability to combat inflation responsibly to engineer an economic “soft landing”. The overall market is in a precarious position, and it’ll likely take successive downward CPI readings before rates will stabilize and the markets can appreciate higher.

Inflation – 40 Year Highs:

Inflation pushed higher in May as prices rose 8.6% from a year ago for the fastest increase in nearly 40 years. Excluding volatile food and energy prices, core CPI was up 6%. Both CPI and core CPI exceeded estimates and came in hotter than expected. Surging costs for shelter, gasoline and food prices all contributed to the increase. The latest CPI numbers casted doubt that inflation may have peaked and adds to fears that the U.S. economy is nearing a recession.

The CPI report comes at a time when the Federal Reserve is in the early stages of a rate-hiking campaign to slow growth and bring down prices. May’s report likely locks-in multiple 50 basis point interest rate increases ahead. With 75 basis points of rate rises already put in place, markets widely expect the Fed to continue tightening through 2022 and likely into 2023.

Target and Walmart Harbinger:

Target (TGT) and Walmart (WMT) warned that its profits would take a hit from an inventory glut. Microsoft (MSFT) also issued a profit warning and said that revenue would be softer than expected due to unfavorable foreign exchange rates. Strategists say they expect to see more companies issuing profit warnings.

Inventories at some retailers have been building, as consumer demand shifted to different categories as Covid cases fell and consumers returned to social events and other activities. Higher costs are also playing a role, especially as consumers are pinched by record high gasoline and rising food prices.

These profit warnings are two-fold: 1) margins will be squeezed by reduced demand and a stronger dollar and 2) this may signal the peak of the inflation cycle via inventory glut and rising interest rates. The former will take time to flow through quarterly earnings while the latter may finally spur this bear market.