Inflation Heating Up

Earlier this week, we received both CPI and PPI data, pointing to an economy still dealing with inflationary pressures. CPI came in slightly above expectations in April, while PPI surprised more meaningfully to the upside. Investors should closely monitor how these trends flow into PCE inflation data. Given the differences in how CPI and PCE weight certain categories, particularly software-related services, the AI boom could lead to a larger-than-normal divergence between the two inflation measures. Overall, this will be an important signal to watch going forward, as markets remain highly sensitive to inflation news. 

Currently, CPI sits roughly 0.7% below its 5-year average. Historically, forward equity returns have tended to worsen as inflation heats up, with periods where inflation moves more than 1% above the 5-year average often associated with negative forward S&P 500 returns. 

That said, inflation had been relatively stable in the months leading up to the U.S./Iran conflict, which suggests this recent uptick may be more tied to the move higher in oil prices than a broad-based reacceleration in inflation. 

There are now effectively no Fed cuts priced in for the remainder of the year, while odds of another hike have moved higher. As a result, investors should continue paying close attention to upcoming Fed meetings, especially with Warsh stepping in as Fed Chair. Any return to a “transitory” inflation narrative will likely be met with skepticism, making it important to see just how data dependent this new Fed will be. 

Since 2022, markets have been operating in a backdrop driven more by inflation than growth. That shift has changed how equities react to interest rates. Since 2023, periods when 10-year Treasury yields declined have accounted for nearly all of the S&P 500’s gains. That is a sharp contrast to the 2010s, when markets were more growth focused and equities tended to move higher alongside rates. 

As we continue to stress, we favor high-quality businesses with durable pricing power and operational flexibility that can better navigate an increasingly volatile macro backdrop. 

Source: Bloomberg, BofA, Goldman Sachs, Ned Davis Research, Piper Sandler 

Sebastian Teper contributed to this article.