Inflation getting hot

Last week’s inflation data underscored the extent of the current energy shock. April’s producer price index (PPI), which measures inflation at the business level, came in well above expectations. Headline PPI rose 1.4% month-over-month (m/m), far exceeding the 0.5% forecast, driven largely by a 7.8% increase in energy prices. Even after excluding food and energy, core PPI increased 1.0%, also meaningfully above expectations, as downstream pricing pressures began to emerge.

The key question now is how much of this pressure will be passed on to consumers. Within the PPI release, there was a notable jump within trade services inflation, which measures the difference between prices paid and prices charged to wholesalers/retailers. This likely signals more pain could be coming to the consumer. As of now, consumer inflation is tracking as expected. The April Consumer Price Index (CPI) increased 0.6% m/m, consistent with forecasts, but the year-over-year reading of 3.8% is already significantly above the Federal Reserve’s target.

Kevin Warsh, who was officially confirmed as Fed Chair last week, begins his tenure during this period of significant uncertainty. While the committee is likely to remain divided over the path of short-term interest rates, last week’s data pushed longer-term yields higher. The US Treasury sold new 30-year bonds at a 5% yield for the first time since 2007, signaling expectations for more persistent inflationary pressure.

Other economic data last week remained firm. Weekly jobless claims of 211,000 were at a healthy level consistent with the low fire environment. Core retail sales, which excludes fuel, increased 0.5% month-over-month and modestly beat expectations, pointing to a resilient consumer. Although higher prices are hitting households, a strong labor market and continued wealth effect appears to be providing an offset.