The May CPI report showed that consumer prices increased by 5% on a year-over-year basis in May which was above expectations and the fastest pace since August 2008. Core inflation, which excludes food and energy prices, rose 3.8%. This was the biggest increase in over 3 decades. The largest gain was in used car prices.
While many on Wall Street have been concerned about inflation, the bigger surprise is that stocks and Treasuries were bought on the news. This is an indication that many on Wall Street expected these numbers and are already looking past them to expect some sort of deceleration. This is consistent with the Fed's stance as well.
Inside the Numbers
Economists were expecting a 4.7% reading for May, while the actual 5% print was the most since 5.3% in August 2008. The monthly reading came in at 0.7% which was above expectations of 0.5%. Notably, a year later, the CPI had actually turned negative. What's interesting is that many market-based measures of inflation have started turning lower such as Treasury yields, TIPS, and breakevens.
Now, the biggest debate in the market is whether this is a new inflation regime or a temporary spike due to the unique conditions created by the coronavirus. So far, the market seems to be in agreeance with the Fed as it hasn't been too concerned about these readings.
Some of the strength was driven by categories that experienced supply chain disruptions from the coronavirus such as autos, food, and housing.
Stock Price Outlook
If the market and Federal Reserve are correct in labeling inflation as transitory, then it's likely a great time to pick up interest-rate sensitive stocks and sectors like utilities (NYSE: XLU), dividend stocks, and consumer staples (NYSE: XLP). It could also lead to a rebound for growth stocks as the rise in interest rates was a trigger for the rotation from growth to value.
On a longer-term basis, it removes one threat to the recovery that spiraling inflation would force the Fed to prematurely raise rates. This is consistent with the Fed funds futures market which is showing that rates won't be hiked until 2023.