Inflation Surges

Investors were focused on inflation this week, and the most recent data was stronger than expected. However, soothing comments on the subject from the Fed helped calm investor concerns, and mortgage rates ended the week nearly unchanged.

In June, the core Consumer Price Index, a closely watched inflation indicator which excludes the volatile food and energy components, surged 0.9% from May, above the consensus forecast for an increase of just 0.5%. Particularly large gains were seen in prices for items affected by the pandemic such as used cars and airline tickets. Core CPI was 4.5% higher than a year ago, up from an annual rate of increase of just 1.6% in March, and the highest level since 1991.

During his semiannual testimony to Congress, Fed Chair Powell suggested that it was too soon to begin to tighten monetary policy and that achieving sufficient progress toward full employment was still “a ways off.” He acknowledged that inflation has climbed substantially and “will likely remain elevated” in coming months, but he expects it to moderate over time as imbalances caused by the pandemic ease. Investors viewed Powell’s patient attitude toward inflation as an indication that the Fed is not in a hurry to scale back its bond purchase program, which was good news for mortgage rates.

Since consumer spending accounts for over two-thirds of U.S. economic activity, the retail sales data is a key indicator of growth. In June, retail sales rose 0.6% from May, which was far above the consensus forecast for a moderate decline. Sales were 18% higher than a year ago and well above the levels seen before the pandemic. The strong results were even more impressive in light of current conditions. First, a shortage of new vehicles due to a lack of chips and other components held back auto sales. In addition, consumers have been shifting their spending from goods, which are included in retail sales, to services such as travel and entertainment, which are not.

Looking ahead, investors will closely watch Covid case counts around the world. They also will look for hints from Fed officials about the timing for changes in monetary policy. Beyond that, it will be a very light week for economic reports with a focus on the housing market. Housing Starts will be released on Tuesday and Existing Home Sales on Thursday.