Dollar bulls may continue as inflation rises

A key inflation indicator that the Federal Reserve uses to set policies rose 3.4% in May from a year ago, the fastest increase since the early 1990s, according to data released last Friday. With a higher inflation leading to an unexciting stocks market, this may give dollar some support in the coming weeks.

Though the gain in inflation was the biggest since April 1992, it still met markets earlier expectations. The stock market posted mostly solid gains, while government bond yields were moderately higher. The core personal consumption expenditures price index increase reflects the rapid pace of economic expansion and resulting price pressures, amplifying how far the nation has come since the Covid pandemic-induced shutdown of 2020.

Even though the reading could add to inflation concerns, Fed officials continue to insist that they see the current situation as temporary and likely to abate as conditions return to normal. The core index rose 0.5% for the month, which was below the 0.6% estimate. Including volatile food and energy prices, the PCE index rose 3.9% for the year and 0.4% for the month.

Most of the inflation increase came from energy, with prices rising 27.4% against just a 0.4% gain in food costs. The headline increase was the biggest since August 2008, just before the worst of the financial crisis hit and sent inflation on a path lower that would last throughout the longest economic recovery in US history.

Inflation has spiked recently amid a confluence of factors. Manufacturers of key products have been unable to keep up with the escalating demand that came with the economic reopening, resulting in supply chain disruptions. Increased real estate prices have also played a part as lumber costs have soared, even though that trend has reversed recently.

The current numbers are influenced by what economists call “base effects”, or skewed comparisons with a year ago, when government restrictions put much of the economy in limbo. Those base effects are likely to dissipate when the June numbers come out next month.

A separate part of Thursdays report showed that consumers spending was flat for the month, versus the estimate for a 0.4% increase, while personal income declined 2%, less than the expected 2.7% decline. Those numbers had been distorted, primarily by government stimulus checks that had sharply boosted both income and spending.

After the inflation data, the S&P 500 is quiet to the extent that it is almost disconcerting. As the index has not had a 5% correction based on closing prices since the end of October, it comes to no surprise that the new day traders, who started buying shares in lockdown, think the market will only go up. The last time the S&P was this serene for so long was in 2017, a period of calm that ended with the volatility crash early in 2018, although back then, it was even quieter for much longer.

Look at the performance of types of stocks. They have been swinging around much more than they usually do as investors switch their bets between industries at a pace seen only during a crisis. With this, the month of March has brought the biggest gap between the best and worst-performing sectors since 2002.