Signs of Future Inflationary Pressures Emerging as the Economy Continues to Reopen

The spate of economic reports and market activity last week confirmed a couple of recent trends: Business and consumer spending are growing, and inflation remains a concern. As we marked one year since the COVID-19 pandemic began, President Biden signed a bill that will provide another round of economic stimulus. Meanwhile, the increased distribution of vaccines is allowing more areas of the country to return to normal. As more sectors experience a rebound in activity, the rally in financial markets is also broadening from hyper-growth areas to include pockets of value that previously lagged.

At the same time, long-term Treasury yields continued to press higher last week. We believe this is due in part to the economic recovery, although some signs of future inflationary pressures are rising. The Federal Reserve has signaled a willingness to tolerate higher prices until the U.S. labor market improves meaningfully. While we saw some progress in that area last week, the economy still has plenty of room to grow to return to pre-pandemic employment levels.

WALL STREET WRAP

Pandemic Anniversary Marked With Stimulus and Growing Vaccine Distribution: Following several weeks of debate, President Biden signed the latest COVID-19 relief bill on Thursday, injecting another round of aid into the U.S. economy. The plan includes direct stimulus payments of $1,400 for qualified individuals and $300 of weekly Federal unemployment insurance, in addition to $350 billion to support state and local governments.

President Biden signed the deal on the one-year anniversary of pandemic. Meanwhile, we’re continuing to make progress on the vaccine front, as the U.S. surpassed 100 million doses distributed. A new vaccine candidate developed by Novavax also reported 90 percent efficacy in a phase 3 trial conducted in the U.K.

Inflation Increased at Producer Level: On Friday, we learned that the Producer Price Index (PPI) increased 2.8 percent year-over-year (2.5 percent excluding Food and Energy) in February. This marked the highest growth since 2018, which is the last time the Federal Reserve increased short-term interest rates. Earlier in the week, the Consumer Price Index (CPI) was tamer, showing just 1.7 percent annual growth (1.3 percent excluding Food and Energy) last month. It is common for producer prices to increase in the early stages of an economic recovery, and several businesses said during the recent earnings season that they’ve been successful passing along higher prices to customers; however, that has yet to be reflected in the broader data.

Small Businesses Expect Higher Prices: The National Federation of Independent Business (NFIB) said on Tuesday that its Small Business Optimism index ticked up to 95.8 in February though was likely constrained by a streak of cold weather across the U.S. Below the headline, there were more data confirming that businesses are experiencing inflation. The number of companies raising average selling prices last month was a net 25 percent, the highest since 2008. The number of businesses surveyed that said they plan to increase prices over the next three months jumped to 34 percent, which again was the highest reading in 13 years. One reason behind the rising price environment is that NFIB reported inventory remained near historically low levels in February. Sales trends were also strong, and a record 40 percent of companies surveyed said they’re struggling to fill open positions.

Consumer Confidence Rebounds Sharply: On Friday, the preliminary March reading of the University of Michigan Consumer Sentiment index rose to 83. That’s the highest reading since before the pandemic, driven by gains in all major demographics. According to the director of the survey, Richard Curtin, “The data indicate strong growth in consumer spending during the year ahead, with the largest percentage in gains for services, including travel and restaurants.” Annual inflation expectations ticked down to 3.1 percent, with the five-year outlook of 2.7 percent suggesting price growth should stabilize over time.

Employment Outlook Gradually Improving: The Department of Labor reported on Thursday that weekly initial jobless claims fell to 712,000, which was the lowest figure since last November. The Bureau of Labor Statistics also said Thursday that JOLTs job openings increased to 6.9 million at the end of January, which reflected the highest level since before the pandemic. Taken in concert with the NFIB data, it appears the U.S. labor market continues to improve, as wider vaccine distribution allows for business and travel restrictions to be loosened. However, we still have a ways to go, as more than 9 million Americans remain unemployed and millions more are deemed to have stopped actively looking for work. 

THE WEEK AHEAD

Powell Press Conference in Spotlight: The Federal Open Market Committee (FOMC) will announce its next interest rate decision on Wednesday. There’s little mystery about short-term interest rates: Those will likely remain low until the jobs outlook improves materially from current levels. Rather, the focus will center on Chair Jerome Powell’s press conference. The Federal Reserve has signaled a willingness to tolerate higher inflation and could possibly decide to shift its bond-buying activity toward longer-dated maturities to help flatten the yield curve. Just last week, the European Central Bank (ECB) announced it would front-load bond-buying efforts in an attempt to suppress rising yields.

Retail Sales on Deck: The Census Bureau will announce February advance retail sales on Tuesday. It could be a tough act to follow after 6 percent growth in January; but net savings activity increased during the pandemic, and many U.S. consumers now have more stimulus checks on the way.

Next Look at Manufacturing Sector: On Wednesday, the Federal Reserve will announce February industrial production, providing a fresh look at the robust Manufacturing sector. The report also includes capacity utilization, which offers key insights about inflation. 

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