Last week, we noted that good news is bad news for the markets. Suggesting economic data that comes in stronger than expected could pressure the Federal Reserve to tighten monetary policy more aggressively. Therefore, stock prices may react negatively to incoming evidence that shows economic activity is still running hot. But sometimes, bad news is just bad news. Last week’s consumer price inflation report is a glaring example that elevated prices for just about everything are an ongoing problem for the economy and markets.

The stock market sold off aggressively on Friday after the May CPI report reminded investors the Fed still has a lot of wood to chop to get monetary policy in line with inflation. Headline consumer price inflation rose +8.6% year-over-year (y/y) last month, surpassing March's highwater mark for the current cycle and hitting the highest level since December 1981. Core inflation (excluding food and energy) rose +6.0 y/y in May and was down slightly from April's +6.2% level. However, both measures in May were hotter than expected and quickly put to rest the idea that peak inflation is in the rearview mirror.

Overall, energy prices were higher by over +34% y/y in May, while shelter costs rose at their fastest pace in more than three decades. A surprise uptick in used auto prices and elevated gasoline and food prices kept consumer prices high last month. In addition, owners' equivalent rent (which accounts for 24% of headline CPI) accelerated higher for the third straight month.

Bottom line: Inflation may be peaking, but the process may take longer than most initially assumed. As a result, the Federal Reserve is widely expected to lift its Fed funds rate by 50 basis points at its June meeting this week and by 50 basis points each at the July and September meetings. Following the May CPI report, odds jumped for a 75-basis point increase at this week’s meeting. However, we believe the Fed will follow the script it’s been laying out through recent committee member speeches over many weeks and raise its Fed funds target rate by 50 basis points on Wednesday. Against a backdrop of record-high inflation and Michigan consumer sentiment sitting at the weakest levels since the 1980s, it's no surprise stocks are again struggling to gain traction.

Last week, the S&P 500 Index dropped 5.1%, logging its worst weekly performance since January. The Index closed back below 4,000 for the first time since late May and has given back the gains made since the May 20th low. The NASDAQ Composite ended the week lower by 5.6% and is more than 30% off its November 2021 high. Both indexes have closed lower in nine of the last ten weeks. In addition, the Dow Jones Industrials Average lost 4.6% on the week. For those keeping score at home, yes, stocks have been doing a lot of losing lately.

Helping round out the week, U.S. Treasuries prices declined, with yields on all durations from 2-years upward now yielding above 3.0%. In addition, the U.S. dollar hit a 20-year high against the Japanese yen as the Bank of Japan (BOJ) looks more and more like an outlier compared to its central bank peers when it comes to maintaining an easy rate policy stance. Finally, Gold finished the week higher by +1.3%, while West Texas Intermediate (WTI) crude settled higher by +1.4% to end the week at $120.60 per barrel.
Inflation is a Significant Threat to the Market as it Influences Key Market Dynamics: Rates and Energy Prices

We believe inflation is the most significant threat to the markets and economy today. Along with higher prices, inflation influences two key market dynamics, interest rates and energy prices. We suspect stocks will likely grind lower if both rates and energy prices are headed higher. However, our view remains that core inflation may peak in the months ahead, but the evidence of the peak may not look linear. Although broader energy and food prices could remain elevated as the war in Ukraine and supply disruptions continue, higher prices for goods could moderate over the coming months. A recent Washington Post poll of Americans showed most expect inflation to get worse this year, with nearly nine in ten respondents indicating they are now bargain hunting for cheaper products. Three-quarters of respondents said they have dialed back their spending on restaurant and entertainment purchases while delaying planned purchases. In addition, Bank of America recently noted that spending is moderating in many categories, and gas accounts for a higher allocation of card spending today.
Bottom line: As food and energy prices have soared this year, there is less discretionary money to spend in other areas, particularly for lower-wage earners. Over time, we believe changing consumer habits, easing supply chain pressures, and higher rates will help bring down inflation. This is a good thing. The unanswered question for investors, however, is how disruptive to growth will the process look.        

Notably, the May CPI report was one of the last inflation data points the Federal Reserve will see ahead of Wednesday’s FOMC announcement. On Tuesday, the Producer Price Inflation (PPI) report will be released, and headline inflation is expected to rise +0.8% m/m, faster than the +0.5% pace in April. Historically high inflation is unlikely to remove the potential risk of the Fed overtightening monetary policy. Stocks appear to be having a challenging time with this concept.
Inflation Data Looks Messy and Mixed; High Prices Across the Board Raise Chances of the Fed Making a Policy Error
While the Fed continues to signal it won’t move more aggressively than what is currently outlined in consensus forecasts
for rate hikes, persistently high prices for almost everything risks a policy error, in our view. Therefore, investors have been unable to discount the chance the Fed will hike rates too aggressively and send the economy into a recession. Unfortunately, inflation data that looks messy, mixed, and in some cases continuing to rise, as we’ve seen in April and May, keep this risk top of mind for investors.
Overseas, the European Central Bank (ECB) announced last week it would end asset purchases on July 1st and increase its target rate by 25 basis points at the July 21st meeting. The ECB also said it plans to raise rates in September and left the door open for a 50 basis point increase if inflation pressures remain persistent. If you think the Fed is behind the curve, the ECB looks like it's still getting dressed in the locker room.
Investors should recognize that it’s not all doom and gloom out there. Stock volatility could come down when the Federal Reserve and other Central banks start to signal they have hiked rates and/or removed enough monetary accommodation to tame inflation. While we are likely a ways off from a less hawkish Fed, the market will look to anticipate the shift ahead of any such announcement, and we suspect stock prices could react positively.
Despite Negative Economic News, Consumers are Still in Good Shape; Now is the Time to Focus on What May Help Mitigate Volatility  
Over the coming weeks and months, we expect analysts to reduce earnings estimates, an increasing number of companies to issue negative profit guidance for Q2, and make mention of higher costs eating into profit margins. Market bottoms are often formed once the deck chairs are reset, and stocks stop reacting negatively to bad news. Importantly, the demand environment remains strong. The economy is likely to grow this year, consumers are on solid footing, the job market is tight, and a lot of pain has already occurred in the stock market. Therefore, this is the time to double down on your well-diversified strategy (which is likely outperforming an all-stock portfolio this year), concentrate on what's working, and make plans for being proactive in capturing the opportunities created during market downdrafts.
Now is an excellent time to schedule a check-up with your Ameriprise financial advisor (if you haven’t already). With guidance from your financial advisor, you can review current market conditions, portfolio allocations, and investment solutions. In addition, your financial advisor can help identify solutions and strategies that may help mitigate volatility and complement a well-diversified portfolio. And while we don’t offer tax advice, it’s not too early to consult your tax advisor to start thinking about smart tax-loss harvesting strategies, given the broad-based stock and bond declines this year.
Lastly, and in addition to the closely-watched Federal Reserve meeting and PPI report this week, the May retail sales report will provide an important look into where and to what degree U.S. consumers are spending money. FactSet estimates call for retail sales to cool in May for obvious reasons. Updates on small business sentiment, import/export prices, building permits, housing starts and industrial/manufacturing production round out this week's economic calendar.

Important Disclosures:
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances.

Some of the opinions, conclusions and forward-looking statements are based on an analysis of information compiled from third-party sources.  This information has been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Ameriprise Financial. It is given for informational purposes only and is not a solicitation to buy or sell the securities mentioned. The information is not intended to be used as the sole basis for investment decisions, nor should it be construed as advice designed to meet the specific needs of an individual investor.

Stock investments involve risk, including loss of principal. High-quality stocks may be appropriate for some investment strategies. Ensure that your investment objectives, time horizon and risk tolerance are aligned with investing in stocks, as they can lose value.

10-year Treasury note is a debt obligation issued by the United States government that matures in 10 years. The 10-year yield is typically used as a proxy for mortgage rates, and other measures.

The fund’s investments may not keep pace with inflation, which may result in losses.

A rise in interest rates may result in a price decline of fixed-income instruments held by the fund, negatively impacting its performance and NAV. Falling rates may result in the fund investing in lower yielding debt instruments, lowering the fund’s income and yield. These risks may be heightened for longer maturity and duration securities.

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An index is a statistical composite that is not managed. It is not possible to invest directly in an index.

The Standard & Poor’s 500 Index (S&P 500® Index), an unmanaged index of common stocks, is frequently used as a general measure of market performance. The index reflects reinvestment of all distributions and changes in market prices but excludes brokerage commissions or other fees.  It is not possible to invest directly in an index.

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West Texas Intermediate (WTI) is a grade of crude oil commonly used as a benchmark for oil prices. WTI is a light grade with low density and sulfur content.

The Consumer Price Index (CPI) measures change in consumer prices as determined by the US Bureau of Labor Statistics.

The Michigan Consumer Sentiment Index (MCSI) is a monthly survey of consumer confidence levels in the United States. It is a statistical measurement of the overall health of the economy as determined by consumer opinion. It takes into account people's feelings toward their current financial health, the health of the economy in the short-term, and the prospects for longer-term economic growth, and is widely considered to be a useful economic indicator.

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Alison Mueller

Email: alison.mueller@ampf.com
Phone: 612-678-7183