INSIGHTS

Financial Industry Insights from Advisors Asset Management

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Higher Inflation for Longer


Headline inflation, as measured by the Consumer Price Index (CPI), set yet another 40-year record, breaching 9% — more than the expected 8.8%. It may be of little comfort, but Core CPI did decline for the second straight month (as we projected last month) but remains high at 5.9%.

Energy CPI was once again the largest culprit, but the main story for us is the continuing surge in “sticky” inflation. We believe credit investors need to stick to companies with strong pricing power and ensure adequate compensation for risk.

Sticky inflation is an even larger concern now

The “flexible” energy CPI category was up 7.5% month-on-month from 3.9% last month, accelerating more than any other main category.

Sticky CPI indicators (chiefly healthcare and shelter) accelerated to their fastest levels yet this cycle and are showing no signs of slowing down (Table 1). This is far more of a concern for us.

Table 1: Energy may command the headlines, but sticky inflation’s rise is the real story

insight1_071422Source: Bureau of Labor Statistics, Bloomberg, July 2022

Easing commodity markets imply energy CPI will likely ease

Commodity prices have retreated over the last few weeks, with the Goldman Sachs S&P Commodity Index down 20% from its June high and is back to levels before Russia invaded Ukraine.

This has helped U.S. gasoline prices fall almost every day for the last month (Figure 1), which has not been fully captured in this CPI report, but should be next month.

Figure 1: Gasoline prices have started to reverse course as commodity strength has eased

 insight2_071422Source: Bloomberg, July 2022. Past performance does not guarantee future results.

Further, declines in wheat, natural gas, lumber, and concrete markets also bode well for a potential easing in flexible CPI categories.

Sticky inflation is surging — and this could be a persistent threat

Inflation in core services is running above 5% year on year. The three- and six-month annualized rates are even faster, suggesting things are getting worse (Figure 2).

Figure 2: Sticky services inflation categories have been accelerating at a concerning pace

insight3_071422Source: FRED, July 2022

We expect more pain yet from health insurance inflation, which we expect to peak at ~20%.

Even more of a concern is shelter inflation, an area we have covered in depth, given its much larger weight in the CPI index. We believe that it would take months of slowing home price appreciation and disposable income for this category to cool.

Peak CPI could be close, but we expect target CPI is not

It will be mathematically difficult for CPI to reach the Fed’s 2% target anytime soon. Even if monthly CPI was zero for the next 18 months, it would still take until Spring 2023 to bring annualized CPI to 2%, and we would still be above 5% at year-end 2022 (Figure 3); even getting to 3% will realistically take approximately 12 months in our view.

Figure 3: Mathematically, it could be tough for CPI to fall to target anytime soon

insight4_071422Source: FRED, July 2022

The Fed’s rate-hike cycle will likely be even steeper

The FOMC (Federal Open Market Committee) meets later this month, and we expect markets will price in another 75 basis point hike, consistent with last month’s “dot plot.” The recent employment report offers further incentive for the Fed to push ahead.

This would take the upper bound of the Fed Funds Rate to 2.5%, in line with the central bank’s estimate of the long-term “neutral” rate. As such, the Fed may then prefer to hike in smaller increments for the rest of the year, particularly if we do finally see peak CPI set in.

However, we believe investors should be prepared for the Fed to hike more than the market is currently pricing in, meaning further volatility feels inevitable.

In credit, we think companies with strong pricing power and liquid balance sheets may offer the most compelling opportunities for diligent investors. Further, although we often focus on the negatives of inflation, there are some upsides of inflation worth considering for credit investors.

CRN: 2022-0714-10178 R

The opinions and views of this commentary are that of Insight Investment and are not necessarily that of Advisors Asset Management. 

Please note: any forecasts or opinions expressed herein are Insight Investment's own as of July 13, 2022 and are subject to change without notice. This information may contain, include or is based upon forward-looking statements. Past performance is not indicative of future results.


This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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