What would Happen when Inflation Runs too Hot?
June 15-16 would be an important event of the month as the Fed meets. Fed officials have emphasized that they will keep policy easy as they watch to see signs that the economy is really healing. They also contend that higher inflation readings are temporary, since the data is being compared with a weak period last year.
The core personal consumption expenditures (PCE) index was forecast to increase 2.9% after rising 1.9% in March. But it rose faster-than-expected 3.1% as price pressures built in the rapidly expanding U.S. economy. Federal Reserve officials consider the measure to be the best gauge for inflation, though they watch a number of metrics.
The index captures price movements across a variety of goods and services and is generally considered a wider-ranging measure for inflation as it captures changes in consumer behavior and has a broader scope than the Labor Department’s consumer price index (CPI). The CPI accelerated 4.2% in April.
The Fed has said it would tolerate an average range of inflation around its 2% target until it sees inflation sticking at a higher level
If inflation runs too hot, the Fed’s main weapon to combat it is to raise interest rates.
The average monthly return for months where the core PCE has been over 2%, going back to 1989 is (a decline) of 1.6%, with a decided bias toward more defensive sectors like health care outperforming and a very pronounced bias for the technology of all kinds to underperform.
Julian Emanuel, head of equity and derivatives strategy at BTIG, said he studied what happened to stocks when core PCE was above the Fed’s 2% target.
June is not historically a strong month for stocks. Bespoke Investment Group points out that over the past 50 years, the Dow has gained just 0.12% in June and has been positive 52% of the time.
But over the past 20 years, June was far weaker, gaining only 40% of the time. June’s performance is tied with September as the worst month of the year, with an average Dow decline of 0.7%, according to Bespoke.
Reference:
- CNBC, 2021-05-28, “A Big Jobs Report Looms in the Week Ahead, as Markets Enter the Often-Weak Month of June”
- CNBC, 2021-05-28, “A Key U.S. Inflation Gauge Rose 3.1% Year Over Year, Higher than Expected”
