Are Higher Rates Leading to Higher Inflation?

Week in Review

After setting new records for four consecutive days, it was only natural for the markets to take a breather on this Friday in June. The S&P 500 closed with a marginal decline of 0.04%, cutting short its winning streak. However, it was not all doom and gloom as the index managed to secure an overall gain of 1.6% for the week.

This week's developments have brought attention to the possibility of inflation finally easing its grip. The release of both the consumer and producer price indexes revealed a softer-than-expected inflation rate, signaling a step forward in achieving the Fed's target of 2%.

Last week which brought some positive news for the market bulls. Inflation data was lower than expected, with May's headline CPI inflation at 3.3% year-over-year, falling below both forecasts and the previous month's reading of 3.4%. This comes as a relief after a series of higher inflation readings in the first quarter of the year.

PPI or business inflation, which generally gets less headlines than its consumer counterpart, went negative for the month of May. PPI is generally a leading indicator of consumer inflation.

At its June meeting, the Federal Reserve decided to keep interest rates unchanged at 5.25% - 5.5%. The Fed's updated projections now indicate only one rate cut in 2024, a significant decrease from the three cuts estimated in March. However, the Fed maintains its forecast of the fed funds rate reaching 3.1% by 2026. Essentially, while the pace of rate cuts may have shifted, the overall plan of the Fed remains unchanged: Interest rates are expected to gradually decrease over the next two to three years.

The events of this week have only reinforced our belief that inflation is on a downward spiral.

Are Higher Rates Leading to Higher Inflation?

Despite initial expectations that rapid interest rate hikes would slow demand and cap inflation, the persistently high inflation in the US has surprised economists. This can be attributed to the unexpected impact of higher rates on certain sectors of the economy. For example, in the housing market, the increased mortgage rates have drastically reduced the supply of homes for sale. This has led to a shortage of available homes, driving up home prices and making it more difficult for homeowners to afford larger homes. This, in turn, has also contributed to higher rent costs and homeowners' equivalent rent, which are significant components of the core CPI. Additionally, the elevated borrowing costs have made it challenging for builders to increase the supply of housing.

Furthermore, the record-high levels of the stock market and robust home prices have led to continued spending by upper-income households, who play a crucial role in driving consumer spending in the US. This sustained consumption by wealthier individuals, despite the high rates and inflated prices, is contributing to ongoing demand and hindering disinflation. Moreover, the corporate sector, which holds significant amounts of cash, is benefiting from higher rates through increased interest income. This cash is often returned to shareholders, further boosting income for wealthier households. Additionally, companies are continuing to hire, which is adding to the overall demand in the economy.

Overall, despite the intention of higher rates to curb inflation, their impact on the housing market, savings disparity, and corporate sector resilience has contributed to ongoing inflationary pressures in the US.

Economic & Earnings Calendar

On Monday and Tuesday, homebuilder companies Lennar and KB Home will release their latest financial results, followed by Accenture, Darden Restaurants, and Kroger on Thursday. CarMax will round out the week with its report on Friday.

Portfolio name Jabil, contract manufacturer and Apple supplier, reports earnings Thursday morning. Options are pricing in a 10% move on earnings. JBL trades at only 12x earnings and has a PEG Ratio at a very reasonable 1.2x (this statistic divides PE by expected growth). According to FactSET the average analyst target is $147. Apple accounts for about 20% of revenue and they have been reported to make the AirPods for Apple among other devices.

The Census Bureau is set to publish its retail sales data for May on Tuesday, providing insight into consumer spending. Additionally, on Friday, S&P Global will release its Manufacturing and Services Purchasing Managers’ Indexes for June, offering a glimpse into the current state of the economy.

International markets will also be in focus, as both the Bank of England and the Swiss National Bank are expected to announce monetary policy decisions on Thursday. The SNB is projected to make its second quarter-point decrease since March, while the BoE is anticipated to maintain its current benchmark rate target.

Chart of the Week: Change in home ownership rate by state

Disclaimer: The author of this blog is a financial advisor but may not be the right advisor for you. In fact, the author may not even be the right advisor for themselves. Please consult a qualified professional before making any financial decisions based on the content of this blog. And remember, just because the author has a fancy title and a briefcase full of spreadsheets, doesn't mean they know what they're doing.