Last week’s inflation data showed that pricing pressures are at their strongest point of the economic cycle. To us, these reports are much less alarming than their headline readings suggest.
While signs of price and wage pressures have been building, we believe the overall inflation environment may not prove as threatening as many investors fear. As shown in our LPL Chart of the Day, core personal consumption expenditures (PCE) is just now reaching policymakers’ 2% target and remains below levels reached ahead of the last tightening cycle. On the income side, average hourly earnings rose 2.7% year over year in July, which is historically low considering the past five recessions started with wage growth in excess of 4.0%.
“We believe it’s important for investors to look deeper into the inflation data,” according to LPL Research Chief Investment Strategist John Lynch. “We maintain our emphasis on core PCE and wage growth, both of which have lagged policymakers’ targets. Consequently, we look for the Fed to maintain its gradual pace of interest rate increases and balance sheet reduction.”
Drilling down on consumer and producer prices helps to explain our views on core PCE and wage growth.
While the July core readings for both the Producer Price Index (PPI) and Consumer Price Index (CPI) came in at or near cycle highs, details underneath the headline numbers show evidence of price stability, not runaway inflation. Year over year growth of 2.7% growth in core PPI (excluding food and energy prices) was driven by primarily by increasing goods prices. However, service prices gained just 2.6% over the same period. Since services comprise approximately 80% of economic output, we will have to see more price growth from this segment of the economy before sustained pricing pressures become a concern.
Core CPI growth, at 2.4% year over year, was slightly above the peak of 2.3% achieved three times since 2008. However, in each of those instances, core readings declined below 2.0% over the ensuing 12 months, begging the question of whether peaks in core CPI this cycle are self-sustaining or self-correcting.
Overall, the data underlying the core readings for consumer and wholesale prices, along with subdued core PCE and tepid wage growth, suggest to us that there is ample time before inflationary price and wage pressures can weigh on economic output.
For more analysis on recent inflation data, check out our Weekly Economic Commentary.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The economic forecasts set forth in this material may not develop as predicted.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. All performance referenced is historical and is no guarantee of future results.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
This research material has been prepared by LPL Financial LLC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.
The investment products sold through LPL Financial are not insured deposits and are not FDIC/NCUA insured. These products are not Bank/Credit Union obligations and are not endorsed, recommended or guaranteed by any Bank/Credit Union or any government agency. The value of the investment may fluctuate, the return on the investment is not guaranteed, and loss of principal is possible.
Member FINRA.org / SIPC.org