Q3 is shaping up to be a collision course of the economy, policy and markets. Data watching will become a full-time sport, with inflation, wage, commodity and employment data all feeding into expectations of when the Fed will begin its inevitable swing toward tightening. Equity markets have remained sensitive to interest rates and yield curve dynamics, all of which stand to shift rapidly as our economy continues this unprecedented recovery.
- Inflation data will be an overarching focus in Q3, including distortions from the 2020 shutdown, wage data and inflation expectations.
- The Fed has made a hawkish pivot and faces the complicated task of communicating timing to markets.
- Strong market fundamentals will likely continue in Q3, but the trajectory of this extraordinary cycle is changing in ways that could challenge investors into 2022.
All eyes on inflation
Inflation is dominating the economic discussion, and with good reason. We expect this to only intensify in the coming quarter. Inflation surged in Q2 in large part due to base effects in the year-over-year calculation as the sharp price declines of 2020 led to an offsetting price jump. Still, the headline was shocking: Consumer prices rose 5.0% year over year in May, the highest in 13 years. Core CPI, which excludes food and energy, hit 3.8% y/y, the highest since 1992.
Is rising inflation technical, transitory or will it turn into a sustained trend of quickening price acceleration? A close look at the data shows offsetting trends and distortions, and the outlook is far from clear. We examine whether inflation is hot or not, and what clearly looks technical versus what price increases have intensified during the early recovery. From here, the details will be even more important, even though the headline year-over-year rate is expected to ease.
Inflation is a much bigger topic than just consumer prices. Wages, input prices, commodity prices and inflation expectations are all part of this vital economic concept and will churn around markets to influence policymakers and investors.