Major U.S. stock indices finished mixed this week. The S&P 500 Index reached a new record high on Thursday, while the Dow Jones Industrial Average could not overcome an early week decline and finished lower for the week. Thursday’s inflation report highlighted critically important pieces of economic data; investors digested the future implications of the results and continued to stake out positions on the two sides of the inflation debate.
For the week, the S&P 500 Index finished up 0.4%, while the Dow Jones Industrial Average fell 0.8%. Year to date, the S&P is up 13.1%; the Dow has gained 12.7%. Unemployment figures trended positive, as weekly first-time claims declined to 376,000 and continuing claims fell by 258,000 to 3.5 million. The overall tenor of job creation coming out of the pandemic is good, not great. Enhanced unemployment benefits still serve as a headwind to service-sector hiring, as evidenced by the record 9.3 million job openings reported this week by the Bureau of Labor Statistics.
Both headline (all goods) and core (excluding food and energy) consumer inflation numbers for May were elevated in month-over-month and year-over-year comparisons. There is little debate that inflation has spiked; indeed, the headline number of 5% (year over year) was the fastest since 2008. However, there are two competing theories as to why inflation is occurring: 1) Unprecedented government spending is causing the start of a new long-term, higher inflation regime and 2) base effects (comparisons to last year’s pandemic-influenced numbers) and worldwide supply chain imbalances as businesses ramp back up are producing a transitory effect. We believe that elevated, persistent inflation will not occur in the short term while labor-market slack and a GDP output gap remain present in the economy. We also contend that disinflationary factors – such as slow U.S. population growth and rising levels of government debt constricting economic growth – are still relevant and could help restrict intermediate and long-term inflation prospects.
The bond market seemed to be expecting the inflation spike and had priced-in the higher number. While the Federal Reserve directly sets short-term interest rates, longer-term rates fluctuate based on expectations for economic growth and inflation. The decline in yield of the bellwether 10-year U.S. Treasury note this week indicates a forward-looking view that inflation and economic growth will be more subdued once the effects of the pandemic are behind us.
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