Equity and bond market volatility edged higher, due to a stronger-than-expected increase in US CPI inflation
Equity markets demonstrated elevated volatility in the past week, with the S&P500 declining by 1.4% wow (+11% YtD), mainly due to a -2.1% fall on May 12th, following the release of stronger-than-expected US CPI data for April. Option-implied volatility (Vix) rose to a 2-month high of 28%, albeit the S&P500 recouped a portion of its losses by the end of the week.
Both the headline and the core CPI index, overshot consensus estimates by a wide margin, with their annual growth at multi-year highs (4.2% yoy & 3% yoy, respectively). That development fed through to higher market interest rates (US Treasury 10-yield: +7 bps wow to 1.63%), reflecting, inter alia, concerns for an earlier withdrawal of the ultra-accommodative US monetary policy stance.
Looking forward, CPI inflation is expected to accelerate further in May (at +4.5% yoy for the headline and at +3.3% yoy for the core index, according to the Federal Reserve Bank of Cleveland Inflation Nowcasting model), due to a further normalization of pandemic-hit items as the economy fully re-opens, as well as an intensification of some of the favorable base effects currently at play.
Nevertheless, there is still little evidence to challenge the Federal Reserve’s view, that the ongoing inflation spike is temporary. Indeed, according to our estimates, the annual pace of growth of the headline CPI will peak in May and later on will revert towards 2% by early-2022.
A risk to the aforementioned benign outlook, is a possible feedback loop between spiking CPI readings and higher inflation expectations (consumers and businesses). In that context, respective data, will be closely monitored in coming months.
The annual growth of CPI appears a biased indicator for capturing underlying inflation trends at the current juncture, as it is heavily distorted by base effects. Indeed, prices for some items were particularly depressed a year ago (especially oil), due to the pandemic-related lockdowns.
Instead, assessing prices with the same month two years ago, with a conversion to an annualized rate, broadly eliminates these effects. According to that metric, inflation pressures are still range bound at circa 2.2% in April and are expected to remain so, supporting the view for the transitory nature of the ongoing headline spike.
Trimmed-metrics of inflation, which exclude outliers (e.g. used cars and trucks rose by +10% mom) and focus on the interior of the distribution of price changes, hover around 2.4% yoy.
On the other side of the Atlantic, according to the European Commission, the gradual relaxation of the measures to stem the spread of Covid-19, which started recently and is expected to intensify in the coming months, will lead euro area GDP higher by 0.9% qoq in the current quarter, +3.2% in the next one and +1.4% in Q4:2021 (following a -0.6% qoq in Q1).
The aforementioned scenario, points to GDP growth of +4.3% yoy in 2021, followed by +4.4% yoy in 2022 (-6.6% in 2020), in line with our estimates. The latest projections represent an upward revision compared with three months ago (+3.8% in both 2021 and 2022), mostly due to the incorporation of the Next Generation EU programme (€750 bn or 5.25% of 2019 GDP).