Weekly Market Update - 6 June 2022

Consumer Spending Buckling Under The Weight of Inflation

Overall demand remains resilient despite macroeconomic headwinds. The earnings disappointments from some retailers were mostly tied to cost pressures rather than weakness in consumer spending.

Adjusted for inflation, consumption increased in April at its fastest pace in three months, supported by solid job growth and accumulated savings.

Consumers continue to spend, but 1) spending is gradually shifting away from goods toward services as the pandemic headwinds fade, and 2) retailer earnings signal a potential divergence among consumers by income brackets.

FED Policy

The Fed may be more flexible than feared after two likely outsized rate hikes in June and July. The No. 1 concern for investors is that the Fed will increase rates too far, pushing the economy into a recession. The release of the minutes from the May Fed meeting provided some relief to the markets.

Even though the minutes confirmed a hawkish path early on, they also hinted at more flexibility later. Most officials judged that a couple more 0.5% rate hikes will be appropriate, which is what the bond market is currently pricing in.

Inflation Is Here To Stay

The Fed's preferred measure of inflation slowed in April from March, and market-based inflation expectations have declined from their peak, fully reversing this year's spike. The four-decade-high inflation keeps the pressure on the Fed to act. While the annual rate of price increases appears to have crested, there is little evidence that it will fall back to the Fed's 2% target anytime soon.

The five- and 10-year expectations (what market participants expect inflation to be in the next five and 10 years, on average) have declined the most over the past month since the start of the pandemic.

As the rise in borrowing costs cools the housing market, demand for goods slows, and supply concerns ease, inflation should remain on a path of gradual moderation for the remainder of the year. That said, the proof is in the pudding.