Is U.S. inflation starting to slow?

On the latest edition of Market Week in Review, Director of Investment Strategies Shailesh Kshatriya and Research Analyst Laura Bardewyck discussed the latest data on U.S. inflation, the U.S. Senate's approval of a $1 trillion infrastructure bill and the recovery in the 10-year U.S. Treasury yield.

U.S. July core inflation rises at slower rate than in June

On 11 August, the U.S. Bureau of Labour Statistics reported that its consumer price index (CPI) climbed 5.4% during July on a year-over-year basis - unchanged from June's reading, Kshatriya remarked. "While this number is clearly well above the U.S. Federal Reserve (the Fed)'s 2% target, it didn't come as much of a surprise," he said, noting that inflation has consistently been running hot since the spring. Kshatriya added that the top contributor to July's inflation numbers came from the energy sector, where prices were up 23% year-over-year.

Of more significance, he said, is that the core CPI for July - which strips out prices from the volatile food and energy sectors - only increased at a rate of 4.3% on a year-over-year basis, marking a slight deceleration from the 4.5% increase logged during June. "Core inflation has been disproportionally boosted by five key categories - hotels, airfares and three auto-related categories - since April," Kshatriya said, "and encouragingly, the July report showed that price pressures lessened in all of these categories." This indicates that the transitory pricing pressures seen over the last several months may be gradually easing, he stated. 

On the other hand, Kshatriya noted that the Atlanta Fed's wage growth tracker - a key indicator of wage inflation - showed that monthly median wages rose 4.5% during July, marking the highest monthly increase since 2007. "One month certainly doesn't make a trend, so I don't want to extrapolate too much from this, but this does show that wage growth continues to be an upside risk to inflation worth watching," he stated.

Infrastructure bill passed by U.S. Senate as Democrats unveil spending plan

Turning to the latest political headlines, Kshatriya noted that on 10 August, the U.S. Senate passed a $1 trillion bipartisan bill to upgrade and expand the nation's aging infrastructure. The bill includes $550 billion for new infrastructure spending, and largely targets traditional infrastructure such as bridges, roads, rail networks and ports, Kshatriya said. The package also includes $65 billion to expand broadband internet access nationwide, he noted.

"One of the key takeaways here is that this bill will improve the productive capacity of the U.S. economy over the long term - and that's a big positive," Kshatriya remarked, adding that it was encouraging to see Democrats and Republicans in the divided Senate find some common ground. The bill isn't a done deal just yet, he noted, as it still requires approval by the U.S. House of Representatives.

Around the same time, Senate Democrats also approved the framework for a $3.5 trillion spending bill, Kshatriya said. "This piece of legislation, which is part of President Joe Biden's much broader economic agenda, targets issues such as climate change and social and healthcare initiatives," he explained, noting that it faces strong resistance from Republicans. Senate Democrats hope to sidestep Republican opposition by advancing the plan through a process known as budget reconciliation, but some more moderate Democrats have already voiced concerns over the size of the bill, which could further complicate things, Kshatriya added.

A key issue for markets is how this bill would be paid for, he said, remarking that the details on this are scant so far. "The tax implications of this bill, particularly as it relates to corporate and capital-gains taxes, will be a very important market watchpoint," Kshatriya observed.

Rise in bond yields, powerful Q2 earnings help boost value stocks

Shifting to bond markets, Kshatriya noted that the yield on the U.S. 10-year Treasury note has climbed approximately 15 basis points from its recent low in early August, trading as high as 1.36% on 12 August. "Up until the past few days, government bond yields had been in a steady decline in the wake of the Fed's mid-June pivot to a more hawkish tone on future monetary policy," he explained. The drop in bond yields, coupled with concerns over the global growth outlook, led to an outperformance in growth stocks relative to value stocks, Kshatriya added.

However, the rise in yields the week of  9 August has contributed to some recovery in the performance of value stocks versus growth stocks, he said. Another factor driving the rebound in value is the exceptional numbers from second-quarter earnings season, Kshatriya noted. "Value stocks are tracking 92% year-over-year growth right now, compared to 48% for growth stocks," he explained, adding that the positive earnings surprise has also been much larger for value.

Looking ahead, Kshatriya said that he expects the global economic recovery to continue, albeit unevenly at times. "While there may be a few bumps along the way, the broader global reopening should remain on track, and that leads our strategist team to prefer value stocks over growth stocks," he concluded. 

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