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Is Inflation a Bad Thing or a Good Thing?

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All 11 sectors in the S&P 500 traded lower this Hump Day; we are currently experiencing the worst selling in the market since early 2021. Major indexes now have a three-day losing streak, with today’s tallies each down 2% or more. Losses accelerated into the close, with the Dow more than 700 points lower at one stage. It finished the day -681 points or -1.99%, the Nasdaq -2.65%, the S&P 500 -2.15% and the small-cap Russell 2000 enduring a hurtful -3.25%.

Clear inflation creep was introduced this morning via April’s Consumer Price Index (CPI), which quadrupled expectations. Though it constituted a big surprise, it wasn’t exactly unexpected — we have been seeing growth in various metrics like productivity and even employment (yes, 266K jobs with average wage gains +0.7% month over month does equal growth) for weeks now, and it appears the real traction is underway.

Despite the worrisome vibe in the market this week, these developments are good things, overall. More vaccinations are allowing more businesses to open, and growing savings accounts look to be put to use into overall economic spending going forward. With vaccinations now extending to school-age children, it’s now legitimately hopeful schools may fully reopen in the fall, which will help put more workers back in their offices.

The Fed welcomes all of this with open arms. Stoking the fires of inflation has proven a very difficult task — going back years now — but it would seem that optimum 2% inflation rate now looks approachable. The 10-year bond yield, often used as a useful guide for overall inflation, rose to 1.69% on the day. After racing up quickly to the 1.7%s a month ago — back when this current market trepidation began — we’ve seen these rates plateau. Best-case scenario would be to get to 2%, but gradually.

The other side of the dual mandate for the Fed is for the economy to get to “full employment,” which pretty much looks like unemployment rates of 3-3.5%. Currently, we’re doubling this, with around 8.5 million jobs from prior to the pandemic still unfilled. So while the market may be experiencing a case of the yips at present, the Fed is staying cool and confident. So far, the Fed has called inflation “transitory;” at what point will they believe inflation is here to stay?

Of course, if inflation zooms past 2% before the Fed does anything to cool it down, the economy could easily overheat, which would obviously bring us new problems we haven’t seen in quite some time. It would mean the Fed’s gambit to usher in higher prices backfired. Yet at this stage, Fed Chair Jay Powell and Company are keeping their game plan in place until the desired results show up definitively in the data.

The Nasdaq is now 8% off its all-time highs, while the Dow and S&P are 4% lower than the new highs they were enjoying as recently as last week. So the rotation out of growth tech names continues as it has for much of this calendar year so far, but it would appear investors are parking in cash instead of cyclicals, at least at this point. Some may call this a correction, others a good excuse to book profits we’ve seen over the past six months or so. Whatever it is, inflation is at the heart of it.

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