Inflation Fears

This morning’s release by the BLS of the April Consumer Price Index has put a small scare into the financial markets. The inflation data showed prices rising surprisingly rapidly, both for energy goods (which was not a surprise), but also for things other than energy.

The annualized inflation rate faced by consumers for all goods other than food and energy (the core rate) over the past six months (November-April) was about 2.8%, which is the highest reading for that inflation measure in five years. The following chart illustrates.

A slightly different measure of inflation that, like the core measure, also tries to smooth out the volatile ups and downs of the overall CPI, is the median CPI inflation rate. Including today’s new data, the median CPI has risen by 2.8% over the past year.

Thus the underlying rate of inflation in the US economy right now clearly seems to be trending higher in recent months, and is now pushing 3%. This is almost certainly higher than the Fed would like it to be, so today’s data substantially increases the likelihood that the Fed will continue raising interest rates further to try to slow down the economy a bit.

What makes this much worse (from the Fed’s point of view) is the decided upward trend in inflation that today’s report seems to be confirming. Stopping this upward trend before it goes any further will be a top priority for the Fed over the next few months. (One should note at this point that one could very reasonably argue that the Fed actually has very little control over what happens to inflation over the next few months, since monetary policy tends to operate with a substantial lag, but that’s a discussion for another day.)

Participants in the stock and bond markets have reacted strongly to this line of reasoning.

Interest rates have been bid up substantially in the bond markets today, with the 10-year US government bond yield rising from about 5.11% early this morning to 5.17% in the first hour after the release of this report. The following chart shows the yield on the ten-year bond over the past two days.

Naturally, the prospect of the Fed trying to cool the economy with further interest rate increases is not welcome news to the owners of US corporations. That’s why the stock markets have reacted rather negatively – the Dow and S&P500 are both down about 1.5%-2% as of 2pm.

It’s amazing what one little report about inflation during just one month can do, isn’t it?