First a weak jobs report, now hot inflation – markets take it all in stride

Brian Nick

The last week’s market highlights:

Each week, we present our featured topics in the context of the major themes listed below from Nuveen's 2021 Q2 Outlook
  • U.S. economy: A strong economic backdrop bodes well for U.S. economic growth.
  • Global economy: Should also surge as large developed countries sprint into the post-pandemic world.
  • Policy watch: No Federal Reserve interest-rate hikes until at least 2023.
  • Fixed income: Take more risk in credit-sensitive parts of the market.
  • Equities: Bullish on cyclicals but looking for opportunities again in growth.
  • Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.

Quote of the week:

"Umm…I don’t…I don’t know…I don’t know if uhh...I don’t quite know how to answer that, to be honest.” – Gerrit Cole

U.S. inflation is not broadly based

Once upon a time, and not all that long ago, inflation consistently stayed well below the Federal Reserve’s year-over-year 2% target, and financial markets gave relatively short shrift to monthly Consumer Price Index (CPI) readings. But no more. It’s safe to say that investors are now scrutinizing inflation data as intensely as they do the monthly jobs report, the “king” of all economic data releases.
In May, the headline CPI rate surged to 5% year over year, while core CPI (which excludes food and energy prices) was up a lesser 3.8%.2 The recent recovery in energy prices accounted for most of this 1.2 percentage point gap. Both figures represent multi-year peaks.3
For the month, headline CPI rose a slightly-above-forecast 0.6%. That was just below April’s 0.8% reading, which matched a 12-year high. Core CPI climbed 0.7%.4
The primary drivers of May’s hotter inflation:
  • A 7.3% jump in used car prices accounted for about one-third of the overall headline gain. Demand for pre-owned vehicles is booming because the supply for new cars has stalled amid a global shortage of semiconductors, hampering automobile production.5
  • Household furnishings became more expensive (+1.3%) as consumers were still spending some of their stimulus-enhanced savings to spruce up their homes.5 In addition to accepting higher costs, homeowners have had to endure longer delivery times caused by supply chain difficulties.
  • Apparel prices (+1.2%) moved higher after contributing little to inflation in April.5 With the economy reopening, people likely wanted to upgrade from their T-shirt and sweatpants stay-at-home wardrobe.
Prices in the service sector, on the other hand, showed no signs of broad acceleration despite heightened demand in the form of more people dining out and attending crowded gatherings like concerts and sporting events. April’s surge in hotel rates faded in May, a sign that lodging capacity may be increasing.6
Looking ahead, monthly inflation could remain elevated as reopening industries push their prices back up to their pre-pandemic levels. But the ultra-low (i.e., below 1%) readings from the spring of 2020 will soon be excluded from the 12-month calculations — likely leading year-on-year gains to plateau or perhaps even drop in the coming months. As a result, we believe May’s inflation numbers are unlikely to prompt the Fed to begin tightening its ultra-accommodative monetary policy.
Moreover, despite last week’s slew of headlines heralding a new era of higher costs, we don’t see serious signs of a broad-based rise in inflation. U.S. Treasury markets seem to agree. The yield on the bellwether 10-year note, which would normally be expected to climb if inflation were approaching worrisome levels, fell 9 basis points during the week to end at 1.47%, near its lowest level in three months.7
Aside from the CPI, we’re also keeping a close watch on supply/demand imbalances in the U.S. labor market. In our view, a persistent lack of available labor supply remains the key inflationary risk for the rest of the year, as employers find themselves having to raise wages to attract workers.
April’s Job Openings and Labor Turnover Survey (JOLTS) report, released last week, revealed a stunning 9.2 million job openings in the U.S. — an all-time high and roughly equal to the number of currently unemployed workers. It took nearly 10 years after the 2007-2009 recession to achieve such a match, but only one year after 2020’s pandemic-driven economic downturn.8
The JOLTS release also showed that a record 2.7% of all employed workers quit their jobs in April, with 5.3% of workers in the leisure and hospitality sectors giving notice.9 Many of these people likely jumped to other  positions for more money because wages for new hires are trending up.
A chunk of the 9.2 million job openings can be found among small businesses, which employ nearly 60 million people, or nearly half of the U.S. private workforce.10 According to May’s National Federation of Independent Business (NFIB) report, 48% of small businesses surveyed reported difficulty finding workers to fill open spots. That’s more than double the report’s long-term average of 22% and significantly above its pre-pandemic level of 38%.11 To try to lure folks off the sidelines, more than a third of business owners reported raising compensation. And about a quarter plan to boost pay in the next three months.11
But it’s not just small businesses that are being forced to “up the ante.” Large companies have had to take similar steps. The end result for all firms could be the same, though: They may need to pass the higher labor costs on to customers, accept lower profits or do some combination of the two.
The key question remains: why are workers so hard to find? Generous unemployment insurance remains a popular and plausible theory. Many lower-paid workers now earn more by staying home. It’s also the explanation with the most optimistic economic forecast embedded in it. Assuming the additional $300/week federal unemployment aid ends as scheduled in early September – or earlier in many states – millions of workers will flood the labor market during the next few months. There are likely other factors related to COVID-19 that are preventing people from returning to work. These should also abate over the summer as vaccinations bring the pandemic well under control. Higher wages, expiring benefits and lower virus case counts should all contribute to strong job creation ahead.

A few nuggets about higher prices

May’s U.S. CPI release garnered the lion’s share of headlines last week, but we spotted a few other newsworthy items on the inflation front:
  • China’s year-over-year CPI rose for the fourth consecutive month in May, to 1.3% — its largest increase since last September.12 But a jump in Chinese inflation is less of a concern for global prices than the spike in U.S. CPI. That’s because, unlike the U.S., China is not a major exporter of food or energy. As a result, its inflation is less “contagious” to the rest of the world.
  • Commodity prices have skyrocketed over the past year. Higher energy prices have made fueling up more expensive, as more Americans have been hitting the road. Iron ore prices have been pushed up by strong demand for steel during China’s peak construction season.
  • Taken an Uber or a Lyft lately? You may have noticed that fares have been steadily rising. Some riders have complained that hailing a driver to go to the airport actually costs more than their airline ticket. Demand for these ride-sharing services has jumped, but finding enough drivers has been a challenge (sound familiar?), so the companies are passing higher costs on to their customers.
    And here’s where unemployment assistance rules come into play. Uber and Lyft have long maintained that their drivers are independent contractors and therefore not entitled to unemployment insurance. But last year’s CARES Act changed that, enabling drivers to qualify for such aid. In fact, they may be precisely the type of workers who are likely to wait until the last unemployment check arrives before driving again.
  1. Marketwatch; S&P 500 and Federal Reserve via Haver; Treasury.gov
  2. BLS
  3. BLS, BLS via Haver, Bloomberg
  4. BLS, BLS via Haver
  5. BLS
  6. BLS
  7. Tresaury.gov, Federal Reserve via Haver
  8. Bloomberg, BLS, BLS via Haver
  9. BLS
  10. Smallbiztrends.com
  11. NFIB
  12. National Bureau of Statistics of China
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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