Stock Analysis & Ideas

Wall Street Shakes off Rising Inflation

Wall Street shook off reports showing that commodity prices continue to rise, at both wholesale and retail levels, subscribing to the theory that inflation is “transitory.”

The CPI Report

A report by the U.S. Department of Labor Statistics, published on Wednesday, showed that the July Consumer Price Index (CPI) — a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services — rose by 5.4% from a year earlier. That’s a 0.5% increase from June, and ahead of market expectations of 5.3%.

These gains were driven by a jump in food prices, new vehicle prices, and shelter.  

The core CPI, which excludes food and energy, moderated to 4.3% in July — from 4.5% in June — and is in line with Wall Street expectations.

The PPI Report

Another report, published on Thursday, showed that the July Producer Price Index (PPI) — a measure of the average change over time in the selling prices received by domestic producers for their products — rose by 7.8% from a year earlier. It’s up from 7.3% in June and ahead of Wall Street expectations of 7.8%. That’s the highest annual rate since November 2010.

Why Wall Street Doesn’t Seem Concerned

Inflation can turn into a big problem for Wall Street in two ways. First, it can force the Federal Reserve to taper, and roll back its quantitative easing program sooner than later, which would lead to higher long-term interest rates. That’s bad news for equities and fixed-income securities, as higher interest rates make alternative assets more appealing.

Inflation also raises the cost of producing goods, which can be a problem for companies with little pricing power. These are companies that make discretionary items in highly competitive environments.

Still, Wall Street doesn’t seem to be concerned about either prospect. Major equity indexes continued to ascend, following both reports. 

The 10-year Treasury bond declined slightly in price as well, pushing yields in the 1.3-1.4% range, up from the 1.2-1.3% range.

Traders and investors are apparently on the same page as the Federal Reserve. They think that inflation is transitory, meaning temporary. In their minds, it is caused by structural impediments in the economy, which is striving to recover from the COVID-19 recession. These impediments include container shortages and port congestions, which raise transportation costs, and eventually commodity prices. 

There are also impediments in the labor markets, wherein unemployment benefits, childcare, and vaccination issues prevent people from getting back to work. The lack of workers makes it hard for companies to produce goods fast enough to accommodate demand.

Wall Street, like the Federal Reserve, believes that inflation will moderate once these impediments are removed and things return to normal.

What evidence do the Fed and Wall Street have to support this view on inflation? First, the moderation in the July CPI, and especially the core CPI. It came in below expectations.

Then, there is the continued “slack” in the labor market and capital utilization, as discussed in previous pieces on the Tipranks’ website. These are the two most essential gauges that the Fed uses to determine how far or close it is to achieving its full employment mandate.

Summary and Conclusions

Wall Street doesn’t seem to be concerned about the rising price of goods and services, thus sharing the Fed’s view that inflation is transitory. It is focused on other factors, like earnings and the $1-trillion infrastructure bill, which funnels more money into the economy, at least for now.

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