US inflation spiked in June. Can this really still be transitory?

Inflationistas received their latest sign on Tuesday that the US economy is overheating and inflation may not be so transitory after all.

Consumer prices rose 0.9% between May and June, said the Bureau of Labor Statistics showed.

This was much higher than economists at Bloomberg were predicting; they had estimated that prices would rise by just 0.5%. But Tuesday’s reading marked the highest one-month change in 13 years, since June 2008.

The consumer price index (CPI) rose 5.4% in June, the fastest pace since August 2008. That was also higher than the 5% rise in May and also beat economists’ predictions of a 4.9% rise.

Excluding volatile components such as energy and food, core CPI jumped to 4.5% in June year-on-year, surpassing the 3.8% reading in May.

Why is US inflation so high?

Market watchers have long been scrutinising US inflation figures for signs of whether the Federal Reserve – the US central bank – will gradually begin to reduce the extraordinary stimulus measures it took during the pandemic and trillions of dollars’ worth of stimulus it has pumped to help the economy survive the pandemic.

After spending months insisting that it will not raise interest rates until 2023, the Fed changed course and stunned markets last month when it raised its inflation forecast and conceded that we may see some interest rate rises by the end of 2023

A third of the rise in CPI last month came from a surge in second-hand vehicle prices, which rose by 10.5% in June compared to May.

The higher prices were also evident in used airline fares, hotel room rates and many other sectors that were hit hardest by the pandemic.

“The June CPI report showed that everything is getting more expensive for the US consumer… Wall Street reacted strongly to a hotter than expected CPI data that sent short-end Treasury yields higher,” said Edward Moya, chief market analyst at OANDA.

All eyes will now be on Fed chair Jerome Powell’s testimony on Thursday and Friday when he is due to appear on Capitol Hill and give an update on the future state of monetary policy.

Tuesday’s reading also makes it harder for Powell to advocate that looser monetary policies still need to remain in place.

US stocks fell at their open after the inflation data was released.

The strong reading raises odds of an earlier tapering

Tuesday’s strong inflation reading also raises the odds that the Fed may make a taper announcement –effectively indicating when it may start rolling back $120bn of bond purchases – at the Jackson Hole Symposium in August.

“A lot of this still looks transitory, but if prices continue to stay elevated, the Fed will have to concede that parts of the surge prices will be transitory,” adds Moya.

Ben Laidler, global markets strategist at multi-asset investment platform eToro, says June’s figures may reverse a sharp decline in both inflation expectations and ten-year yields as the market anticipates an earlier loosening by the Fed.

“We may also see renewed interest in more cyclical and deep-value sectors, such as financials and commodities, at the expense of the high-flying tech sector,” adds Laidler.

So hate it, loathe it, accept it or deny it, inflation is creeping up. So the best thing for investors to do is to inflation proof their portfolios.