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Worries about inflation led to a further tightening of financial
conditions in the week ending June 10.
Fed tightening intended to lower inflation will slow the economy
through tighter financial conditions: lower stock prices, higher
bond yields, wider risk spreads, and a strong dollar. Some effects
are already being felt in the housing sector, where home sales have
fallen, homebuilder sentiment has softened, mortgage applications
have declined sharply, and some indicators of home construction
activity have declined.
Digging into the details, the S&P 500 fell for the second
week in a row and the 11th week of the last 12, leaving it down
18.7% from its January 3 peak. For the week, the S&P 500
declined 5.1% and the 10-year Treasury note yield rose 19 basis
points to 3.15%. On Friday, prompt futures for Brent crude were
trading near $122/barrel, up from $102 on May 10, and the dollar
was trading at $1.05 to one euro.
The dollar appreciated against the euro even though the European
Central Bank said that it planned to begin raising interest rates
next month. Earlier and more aggressive tightening by the Fed
supports a strong dollar. (Europe is also more vulnerable to sharp
increases in energy prices stemming from Russia's invasion of
Ukraine.)
We anticipate that GDP will continue to expand, albeit at a much
more moderate pace on average than last year. In response to data
published after this forecast was prepared, especially the
Quarterly Services Survey for the first quarter, we lowered our
forecast of growth averaged over the first two quarters to show a
slight decline.
CPI moves in May
Inflation remains very high following some easing in prices for
nonfood, nonenergy goods that rose sharply in the past, such as
used motor vehicles. As of May, 12-month changes for the overall
and core CPIs were 8.6% and 6.0%, respectively. Inflation within
core services continues to heat up (to 5.2% in May), driven in part
by accelerating rents. Core goods inflation has declined from its
recent peak yet remains very high (8.5%).
The CPI rose 1.0% in May. The core CPI, which excludes the
direct effects of moves in food and energy prices, rose 0.6% for
the second consecutive month. The headline CPI was boosted by price
increases for food (1.2%) and energy (3.9%).
The 12-month change in the CPI increased 0.3 percentage point to
8.6% in May, the highest since December 1981. The 12-month change
in the core CPI decreased 0.2 percentage point to 6.0%. Prices rose
broadly in May, with notable increases in new vehicles (1.0%), used
cars and trucks (1.8%), shelter (0.6%), and transportation services
(1.3%).
Pain for consumers
Consumers have been feeling the pain at the grocery store this
year. Prices for food at home have increased at or above 1.0% every
month so far this year. The 12-month change in the CPI for food at
home rose 1.1 percentage points to 11.9% in May, the highest since
April 1979.
The rise of core inflation last year initially was led by large
price increases within core goods such as motor vehicles. More
recently, inflation within core services has risen while core goods
inflation has slowed. Still, while down from recent highs, core
goods inflation continues to outpace core services inflation:
twelve-month inflation rates for core goods and services as of May
were 8.5% and 5.2%, respectively.
A quick rebound in rent inflation has contributed to the rise of
services inflation. Owners' equivalent rent (OER) and rent of
primary residence (RPR) each rose a robust 0.6% in May.
Twelve-month changes in OER (5.1%) and RPR (5.2%) as of May are up
sharply from 2.0% and 1.8%, respectively, in April 2021.
FOMC likely to push rates up
With inflation still far above its 2% long-run target (when
measured relative to personal consumption expenditures), the
Federal Open Market Committee (FOMC) is certain to raise the target
for the federal funds rate by at least 50 basis points on
Wednesday, with an even larger hike of 75 basis points now seen as
more likely. The latter would lift the target range to 1½% to 1¾%,
consistent with raising the federal funds rate "expeditiously" to
an approximately "neutral" setting (read: near 2½% for the nominal
federal funds rate).
The FOMC will likely push interest rates above what it
interprets as a neutral level beginning in the fourth quarter of
2022, with further rate increases on tap heading into early 2023.
We expect the upper end of the target range for the federal funds
rate to rise to 3¼% by early next year. It is likely to remain at
that level until 2024, at which time (we project) inflation will be
well on the way to averaging 2% on a sustainable basis.
As part of its pivot to tighter policy, this month the Fed is
beginning to shrink its bond portfolio according to the plan it
announced in May. The pace of shrinkage will roughly double
beginning in September to up to $95 billion per month. Fed
shrinkage reinforces upward pressure on bond yields and should be
well anticipated by participants in bond markets.
Posted 14 June 2022 by Akshat Goel, Senior Economist, US Macro and Consumer Economics, S&P Global Market Intelligence and
Ben Herzon, Executive Director, Research advisory specialty solutions, S&P Global Market Intelligence and
Ken Matheny, Executive Director, Research Advisory Specialty Solutions, S&P Global Market Intelligence
This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.
