Why Inflation Isn't Hitting Markets, Yet
Call it a tale of two weeks.
Last week, from June 21 through June 25, U.S. stocks soared in their best performance since February as the S&P 500 soared 2.7%, the Nasdaq Composite climbed 2.4%, and The Dow jumped 0.7%. But the week before, from June 14 through June 18, U.S. stocks had their worst week since October, as the Dow slumped 3.5%, the S&P fell 1.9%, and the Nasdaq slipped 0.3%.
What explains the divergence, and what does it say about market activity for the weeks and months to come? Inflation, expectations for inflation, and policy responses to inflation seem to be the key factors at play.
Consider the week before last, and what caused the broad market to sell off. On Wednesday, June 16, members of the Federal Open Market Committee expressed their belief the central bank will increase rates in 2023. And a majority said they expect the Fed to hike rates twice that year. Then on Friday, James Bullard, head of Federal Reserve Bank of St. Louis, said he expects rate hikes to begin even sooner in 2022.
The Fed tied these pronouncements to their own prognostications of inflationary conditions. The central bank commissioners said on Wednesday that they see inflation rising to 3.4% this year, a full percentage point above their previous estimate. Chairman Powell tried to reassure investors, saying “Our expectation is these high inflation readings now will abate,” but the damage was done, and investors got spooked.
So what happened last week, causing markets to rise? It appears investors digested the data and realized that, perhaps, Powell was right: inflationary pressures are transitory, and the economy would be moving on. Other events supported this.
In a sign of the economy continuing its “return to normal,” President Biden announced last week that he and a group of Senators had agreed on a bipartisan deal for a $1 trillion infrastructure bill. The prospect of more government stimulus, focused on roads, bridges, the electrical grid and public transit systems, offered investors renewed hope about the economic recovery from the pandemic.
Plus, there was new data that signaled a return in consumer confidence. Spending on goods in the month of May was up nearly 20% from February 2020, and people of all income levels were spending more at restaurants than in months prior. At the same time, The Labor Department reported that the number of workers filings for jobless benefits continued to decrease last month. These data points are encouraging to investors, who perceive it as a recalibration of supply and demand.
Despite the progress, there’s no guarantee the market optimism holds this week. Some market analysts believe we’ve reentered a period of unsustainable froth.
“Investor expectations are way out of whack with reality,” said Michael Batnick, the director of research at Ritholtz Wealth Management in a note this weekend.
In other words, investors best tread carefully.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.