RELIEF: Today’s May US inflation report could be a key inflection point, with year-over-year rates peaking, and month-over-month decelerating sharply. Normalization toward the Fed’s 2% inflation target will be a long road. But we see room for some relief from the remorseless impact of the Fed ‘vice’, of ever higher bond yields and recession risks, on very stressed equity markets.
STICKY VS FLEXIBLE: The Atlanta Fed divides inflation into two (see chart). Goods-heavy ‘flexible’ prices, from fuel to cars and food to clothing, that are the most responsive to the economic environment, make up 30% of inflation, and are running at 20% rates. The other 70% are the more services-heavy forward-looking ‘sticky’ prices, like rent, utilities, education, and medical care, running at 5%. Flexible prices are now peaking, with economy slowing, whilst the Fed is hiking interest rates to reign in sticky prices, driven by tight labour and housing markets.
TO DO: We stay invested. We believe markets are closer to the bottom of the sell-off than the top. Fundamentals are stressed but secure, whether GDP or earnings growth, and sensitive to ‘less bad’ news. Long term returns to buying these levels of pessimism and pullbacks are historically favourable. Yet its a world of high-for-longer inflation and an unprecedented double barrel Fed policy response, with broader risks from Ukraine war to China lockdown. This argues for cheap Value and defensive positions, from commodities to healthcare, to weather the storm.
All data, figures & charts are valid as of 10/05/2022
