Consumer Price Inflation Continues to Move Higher

Consumer Price Index5/13/11: In the markets, as in life, there are no guarantees but everyone is entitled to their opinion. Here’s my opinion on the financial markets today.

The Nitty Gritty Details:

Global markets rose overnight following upbeat German and French GDP data, which helped provide some early support for equities as well as commodities. But early gains faded following this morning’s CPI data, although it was in line and benign. Inflation expectation measures from the University of Michigan come out today along with metrics on consumer sentiment. European markets were higher in mid-day trading on the positive GDP data, some well-received earnings news and gains in mining shares. Asian markets were mixed, with the Nikkei lower and the Hang Seng solidly higher as Asian investors digest China’s latest tightening move. Commodities are broadly higher and the dollar lower, with particular strength in silver, sugar, wheat and cotton.

Looking back at Thursday, stocks staged an intra-day reversal to end the session higher. The late rally followed a sluggish open after another increase in bank reserve requirements from the Chinese central bank, more commodity selling pressure and sharp declines in a major technology company’s shares after disappointing earnings. The dollar staged a reversal of its own as its early gains evaporated, corresponding to the intra-day swing in stocks. Defensive sectors led, as Consumer Staples, Utilities and Health Care each gained around 1%, while Energy and Financials finished with fractional losses. The broad commodities indexes were marginally higher.

Around our financial planning firm this morning, we were discussing four items that we thought would be of particular interest to our readers:

The Markets Broken Down:

  1. Consumer price inflation (both headline and core) keeps moving higher. The April Consumer Price Index (CPI) posted a 0.4% month-over-month gain in April, driven by another surge (+3.3% month-over-month/+33% year-over-year) in gasoline prices. The 0.4% gain was in line with expectations. Core inflation has accelerated from a low of 0.6% year-over-year in October 2010 to 1.3% year-over-year in April 2011, suggesting that one of the Fed’s goals of QE2 (avoid deflation) has been met.
  2. And, divergence between headline and core inflation presents a “communications problem” for the Fed. Overall CPI inflation is now over 3% for the first time since 2008, and even assuming no gain in gasoline prices over the next few months, the year-over-year gain in overall CPI will remain above 3% for most of 2011, while core inflation moves higher, but remains in the Fed’s “comfort zone.” This divergence between overall and core CPI increases the communications problem for the Fed (it focuses on core inflation rather than headline inflation), and probably makes the hurdle for initiating another round of quantitative easing after QE2 expires at the end of June 2011 even higher than it already was.
  3. How do inflation and the dollar impact commodity prices? The dollar impacts how we measure commodity prices since they are global. When the dollar declines in value, commodities are worth more in dollar terms. This can be seen with gold over the past year. Gold is up sharply in dollar terms, but flat measured in yen and down measured in Australian dollars. Inflation can be boosted by rising commodity prices in a number of ways if those higher prices do not crimp consumer spending in other areas resulting in offsetting price declines elsewhere.
  4. What are our expectations for housing and how the banks will be impacted? Housing market weakness continues to weigh on the banks and consumer sentiment. We may see further modest declines, but would note the following factors as supportive of a near-term bottom in home prices: 1) homes are very affordable, 2) a number of key markets, notably in the Northeast, have been resilient, and 3) the job market is improving. We would also note that while home values are important drivers of consumer confidence, the stock market’s impact is a greater determinant of consumer wealth.

As always, email me here with your questions or comments.  I love to hear from you and thoroughly enjoy the “intellectual debate” with our clients and friends that these opinions generate.

Greg Powell, CIMA
Wealth Consultant

Note: The opinions voiced in this material are for general information and are not intended to be specific advice. Any indices such as the S & P 500 can’t be invested into directly. Past performance is no assurance of a future result.

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