Thoughts on US inflation

13 June 2022

This article is written by Julien Lafargue, Chief Market Strategist at Barclays Private Bank.

(Please note: Inflation figures quoted are sourced from the US Bureau of Labor Statistics, as at 10 June 2022.)

While inflation has become a defining topic of 2022, the May CPI print in the US was nonetheless a bit of a shocker.

The headline figure spiked 8.6% year-on-year (Y/Y), above the Street’s consensus (+8.3%) and up from +8.3% in April. Tellingly, the +8.6% represents a 40-year high in the Y/Y increase, surpassing the +8.5% from March.

Core inflation was cooler, rising +6% Y/Y, ahead of consensus (+5.9%) but down from +6.2% in April. The core peak remains +6.5% from March 2022.

Key takeaways

As we highlighted in our recent publications, there was a risk and expectation that inflation might run hotter-than-expected in May, given the recent surge in commodity prices.

At the headline level, energy and food did drive a significant portion of the increase - fuel oil rocketed by 16.9% month-on-month (M/M). Encouragingly, core inflation is showing signs of moderation.

Against that backdrop, here are our initial takeaways from the latest data release:

1: The debate on “peak inflation” will rage on

Bulls will point to the stabilisation in the core component, as well as to the upcoming PCE release. Indeed, the US Federal Reserve’s (Fed) preferred measure of inflation has a 22% weighting to medical care prices – three times more than the CPI – and it cooled down in May.

The bulls among us will also highlight the fact that goods inflation was just 1.7% of the 8.6% CPI Y/Y increase, the lowest since September 2021, while services inflation was 3.0%, the highest in four decades. In this context, as the economic activity slows down (but does not crash), inflation could reverse quite quickly.

On the flip side, bears will argue that the peak is still in front of us and that inflation isn’t going away anytime soon. As an example, used cars prices went up M/M in May after declining for a few months. In the opinion of bears, a recession is therefore the only way out.

2: The Fed “pause” is less likely

The recent rebound in equity markets was driven in part by expectations (following a Fed official’s comments) that the Fed could pause its hiking cycle in September, after increasing interest rates by 50bp in both June and July. After this latest data release, the market is discounting another 50bp hike in September, totally dismissing the idea of a pause. Yet, three months is a long time in the context of today’s markets, and although “a pause” is increasingly less likely, it’s not impossible.

3: The immediate future will be key

While there is little doubt that the Fed will hike at the next opportunity, the market will closely watch the FOMC projections. The current dot plot shows that the Funds rate cap was around 2.8%. If this moves significantly higher, there could be further stress (and vice-versa). In light of last week’s release, it will be hard for the Fed to be even more hawkish than expected (apart from committing to 50bps increments for the rest of the year).

What it means for investors

Although the latest numbers might be considered something of a setback, it does not necessarily change the medium-term outlook. The market will see that a Fed pause is less likely and that a recession is potentially more likely, but we take some comfort from the fact that core inflation remains on a downward trend.

Headline inflation can vary significantly in the short term and there’s currently no indication that by September, we won’t be a few percentage points below current levels (in May 2021 WTI price averaged $65 but was closer to $75 in June).

The real question at this point is: what will the Fed do in September and beyond? We may get some more details soon but the reality is that a lot can happen in a short space of time.

It also seems to us that disinflationary pressures are becoming stronger every day. These include, but aren’t limited to, excess inventory in the retail space, rock-bottom consumer confidence, China’s gradual reopening, and demand destruction.

In this context, we believe that investors will be rewarded if they remain patient and do not succumb to the overly pessimistic mood prevailing at the moment. Until further clarity emerges, they should also prepare for continued volatility. Maintaining a highly diversified exposure feels appropriate.

Related articles

This communication is general in nature and provided for information/educational purposes only. It does not take into account any specific investment objectives, the financial situation or particular needs of any particular person. It not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful for them to access.

This communication has been prepared by Barclays Private Bank (Barclays) and references to Barclays includes any entity within the Barclays group of companies.

This communication:

  • is not research nor a product of the Barclays Research department. Any views expressed in these materials may differ from those of the Barclays Research department. All opinions and estimates are given as of the date of the materials and are subject to change. Barclays is not obliged to inform recipients of these materials of any change to such opinions or estimates;
  • is not an offer, an invitation or a recommendation to enter into any product or service and does not constitute a solicitation to buy or sell securities, investment advice or a personal recommendation;
  • is confidential and no part may be reproduced, distributed or transmitted without the prior written permission of Barclays; and
  • has not been reviewed or approved by any regulatory authority.

Any past or simulated past performance including back-testing, modelling or scenario analysis, or future projections contained in this communication is no indication as to future performance. No representation is made as to the accuracy of the assumptions made in this communication, or completeness of, any modelling, scenario analysis or back-testing. The value of any investment may also fluctuate as a result of market changes.

Where information in this communication has been obtained from third party sources, we believe those sources to be reliable but we do not guarantee the information’s accuracy and you should note that it may be incomplete or condensed.

Neither Barclays nor any of its directors, officers, employees, representatives or agents, accepts any liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this communication or its contents or reliance on the information contained herein, except to the extent this would be prohibited by law or regulation.