Fed’s preferred inflation measure tops 3% as U.S. economy strengthens

On the latest edition of Market Week in Review, Senior Quantitative Research Analyst Abraham Robison and Senior Research Analyst Brian Yadao discussed the latest macroeconomic data from the U.S., a key gauge of the business climate in Germany and recent market performance.

U.S. consumer prices soar. Will the Fed remain accommodative?

Recently released data shows that the U.S. economy continues to recover from the damage inflicted by the coronavirus, Robison said, noting that weekly initial jobless claims dropped to 406,000 for the week ending 22 May. "While still above pre-pandemic levels, that's the lowest number the U.S. has seen since the onset of the pandemic - and it's especially noteworthy given that new weekly claims topped 6 million a little over a year ago," he remarked. In addition, the government's second estimate of first-quarter GDP (gross domestic product) came back unchanged, at an annualised rate of 6.4%, Robison added.

Further evidence of the strengthening U.S. economy was found in the release of the core PCE (personal consumption expenditures) price index, published 28 May by the Commerce Department, he said. "On a year-over-year basis, this index jumped 3.1% in April," Robison stated, noting that the core PCE index serves as the U.S. Federal Reserve (the Fed)'s preferred measure of inflation. While the increase was above the central bank's target of 2%, it was largely expected, due to supply chain bottlenecks and base effects stemming from last spring's drop in prices, he noted.

Because of this, Fed officials continue to see current inflationary pressures as transitory, Robison said - a point recently emphasised by Vice Chairman Richard Clarida in a 25 May interview. "This view, when combined with the fact that the U.S. is still far from reaching full employment, means that we can probably expect monetary policy to remain accommodative through at least the end of the year," he stated. Ultimately, the Fed is much more likely to allow inflation to overshoot its target than to risk a disinflationary environment, such as the one Japan has grappled with since the 1990s, Robison noted.

Positive economic outlook for Europe as German business sentiment soars

Switching to Europe, Robison said that Germany's Ifo Business Climate Index - which measures the sentiment of more than 9,000 German businesses in the manufacturing, services and trade sectors - rose to a two-year high in April.

"The index hit a reading of 99.2, which is important, because it indicates increasing optimism around the state of the German economy, which is Europe's largest," he stated. The Ifo survey is conducted on a monthly basis - versus GDP readings, which are published quarterly - and is a well-established early indicator of German economic trends, Robison said. "At the end of the day, a positive outcome in this survey is good news for the European economy," he concluded.

Equities rise as markets look ahead to next U.S. employment report

Turning to recent market performance, Robison noted that the week of 24 May was largely calm for equities, with both the Dow Jones Industrial Average and the S&P 500® Index ending the week up about 1%, as of midday Pacific time on 28 May. Bond markets were also largely range-bound, he said, noting that the yield on the 10-year U.S. Treasury note ended the week relatively unchanged.

Commodities, meanwhile, increased slightly on the week, continuing a steady upward climb from the beginning of the year, Robison said. "With lumber prices, chip prices and iron ore prices all on the rise, we might be seeing some signs of transitory inflation," he remarked.

Robison concluded the segment by noting that markets will be paying close attention to the upcoming U.S. jobs report for May, which will be published by the Bureau of Labour Statistics on 4 June. "The April employment report was a disappointment, so the May numbers are going to be an important watchpoint for investors," he stated.

Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.

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