Inflation soared 7% in 2021 according to Consumer Price Index (CPI) data released this morning by the Bureau of Labor Statistics, as seen in the LPL Chart of the Day, its highest level since 1982. There was little consolation in the “core” reading (excluding food and energy). While a little tamer, it still rose 5.5% in 2021, its highest reading since 1991. Financial markets seemed to shrug off the result with the S&P 500 Index climbing in early trading and the 10-year Treasury yield declining.
“The headline inflation number this morning is eye-popping—a 7% increase in prices over the last year, the highest since 1982,” said LPL Financial Asset Allocation Strategist Barry Gilbert, “but it was largely expected. While it doesn’t change the Fed’s timeline, we could still see interest rate lift-off as early as March.”
We’ve been saying for a while that we didn’t expect the peak in one-year inflation numbers until early 2022 and further supply chain disruptions from the Omicron variant strengthen that case. But the more important question right now is the exact timing of when inflation might start to slow, since ultimately that will likely determine how aggressive the Federal Reserve (Fed) will be.
Vehicle sales continue to have an outsized impact on the inflation number, especially prices for used cars and trucks, which rose 3.5% in December and were up over 35% for the year. The Fed will also be closely watching shelter inflation, since it tends to be sticky. Prices for shelter (excluding energy) rose 0.4% in December, slightly slower than October and November at 0.5% but a faster trend than what the Fed likely wants to see. Apparel and household furnishings also saw a sizable jump.
The numbers will likely make for a lot of dramatic headlines this morning, but for markets the key to the report was that it remained in line with expectations. With inflation running hot, concerns about the impact of a meaningful upside surprise had increased, and simply remaining in line with expectations was practically a win.
Right now, markets are largely focused on inflation because of its impact on how quickly the Fed might tighten monetary policy. With inflation at 7% and the unemployment rate at a healthy 3.9%, it’s no surprise that the Fed has pivoted toward tightening. The Fed may want to signal that the process has begun by rising rates as early as March. We believe equity markets can easily absorb the first few rate hikes, as they typically have historically. But persistently high inflation, while not our base case, would bring a more aggressive Fed into play. For now, that’s not our expectation, and there isn’t anything that we saw in the December CPI data that shifted our view.
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