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Hot CPI Report Stokes Fears of “Entrenched” Inflation

Yesterday’s CPI report was expected to show moderating price increases led by falling energy prices. Instead, the 0.6% monthly increase in core prices took markets by surprise, with stock markets dropping dramatically, erasing recent rallies – which were largely based on softening inflation hopes. Price increases are broad-based – shelter costs, health care, restaurants, and travel are all experiencing high demand from a consumer base that has experienced a 6.7% increase in wages over the past year (that figure is the highest in 40 years). The narrative is changing: falling gas prices, improving supply chains, and lower shipping costs were expected to lead to lower prices. That’s not happening as relentless consumer demand keeps driving prices up. This is hardening expectations that the Fed will have to increase rates higher and longer to accomplish its desire to stifle demand. This was the last major piece of data before next week’s Fed meeting. The futures market is now pricing a 25% chance of a 100 basis point increase in the Fed Funds rate at next week’s meeting. The 10-Year Treasury spiked from 3.29% to as high as 3.46% yesterday, closing at 3.41% today. Piling on: A possible Railroad strike could massively disrupt supply chains as negotiations drag on towards a Friday deadline. Stay tuned…

By David R. Pascale, Jr. , Senior Vice President at George Smith Partners