This past week we experienced a couple of soaring inflation numbers which has injected new uncertainty surrounding inflation peaks, Fed rate hikes and the likelihood of a recession. Let's discuss what happened and what to watch for in the coming weeks.
"I'm your pain – You know it's sad but true" - Sad But True by Metallica
Consumer Prices Soaring
The headline Consumer Price Index (CPI) for June showed prices climbed a scorching 9.1% year over year. Headline inflation includes both food and energy. When you take out food and energy costs, Core CPI came in at 5.9% year over year. Both numbers were well above expectations and put into question whether inflation has peaked.
The Federal Reserve wants core inflation to run at 2 to 2.5% in the long run, so 5.9% is more than double the Fed's comfort zone.
How does the Fed lower inflation? They hike the Fed Funds Rate and shrink their balance sheet, which slows demand and removes liquidity in the financial system.
The problem? A sizable portion of our inflation is energy based which seeps through the entire food and supply chain through shipping and manufacturing plants. Fed rate hikes do not lower oil prices. There are only two ways to lower oil prices:
- More supply
- Recession fears, which means less demand
Recession Signals Emerge
It's important to remember that the Fed controls short term rates, and the Treasury market controls the Fed. Short term rates have nudged higher but longer-term rates like the 10-year yield and home loan rates have not gone up nearly as much. This despite the likelihood of more Fed rate hikes ahead.
In response to the high CPI print, the chance of a full 1.00% rate hike at the July meeting stands at 85%. As a result, the 2-year yield soared to 3.25% and the 10-year moved up to 2.99%. The 25+ basis point yield curve inversion, where the 2-year yield is 25bp higher than the 10-year, is the widest since the spring of 2000...right before a recession.
Back in June, JPMorgan CEO, Jamie Dimon told the world to "brace for an economic hurricane" as some rough conditions were on the horizon. The firm reported quarterly earnings this week and it missed both revenue and earnings forecasts. This miss has elevated fears that more corporations are going to miss earnings which caused stocks to decline sharply on Thursday with some of the money finding the U.S. bond market.
Besides rates likely peaking because of a recession or near recession, there is some more good news.
Oil prices collapse
There are two ways for energy prices to move lower:
- More supply
- Less demand, by way of recession fears
We are watching the latter take place as heightened recession fears have pushed oil to $92 a barrel, the lowest levels since February.
Should oil move lower still, we should expect headline inflation to move lower in the months ahead which would be a welcome sign.
Bottom line: Long-term rates have stabilized but we should not expect much more improvement until inflation moderates further. With that said, if you are interested in purchasing a home, it remains a great time with rates well beneath the rate of inflation.
Next week brings some housing data. These reports could further confirm whether the economy is at or near a recession. The Fed wanted to remove some froth from the housing market by talking up rates. It appears to have been successful in that endeavor. There will be limited Fed speak as we approach the quiet period, one week before the next Fed Meeting on July 27th.