Unease About Continued High Inflation Dogs the Market

A higher May CPI is not good news for the markets.

The stock market is uneasily anticipating Friday’s release of the Consumer Price Index for May. This comes amid talk that the Federal Reserve will go too far in its fight against rising prices and harm the economy.

While some on Wall Street think we have seen peak inflation, there’s also fear that the CPI will stay too high—meaning over 8%—for too long. Feared result: The Fed will keep hammering away and hiking rates, obliterating any chance of a soft landing for the economy.

The S&P 500 is down 0.6% today, following a rally off the slide that began in March. The market finds itself between wanting to believe in the rallies but not believing that the Fed can negotiate a soft landing,” comments Quincy Krosby, chief equity strategist for LPL Financial. 

The CPI posted an 8.3% rise for April, over the preceding 12 months. Projections on Wall Street are for 8.1% in May, a small slowing of the inflation pace. But painful price levels for food and fuel are expected to remain, meaning consumers will see very little relief.

The Fed itself forecasts that inflation will end up at 4.3% for the year, before reaching 2.7% in 2023 and 2.3% in 2024 (these are for its preferred inflation gauge, which is slightly less than the CPI). “It may take longer than we like but I’m confident that we’ll use our tools to bring inflation down,” Powell said at his recent press briefing.

What if inflation remains stubborn? There are big questions about whether the Fed’s tightening campaign will go too far. Ray Dalio, founder of hedge fund powerhouse Bridgewater Associates, recently said that the “pain of that will become great and that will force the central banks to ease again.”

Precedent exists for such about-faces. The Federal Reserve halted its tightening in 2018 after economic indicators flagged, then lowered rates. The European Central Bank raised rates in 2011, yet was forced to do a 180-degree turn later that same year. The Bank of Japan hiked rates in 2006 and then had to reverse its course in 2008.