Inflation's hot, it's rising again, and it's spooking investors.
The headline PCE index rose at three times December's pace. The Fed prefers the PCE as it measures behavior in consumers, rather than just prices. Egg prices, for example, may have risen 8.5% in January, but if no one is buying them because they were so ridiculously expensive, then they're just sitting on grocery store shelves and not really contributing to inflation. However, the increase in PCE indicates that consumers were still buying eggs — and more. Even after taking out food and energy prices, core PCE in January remains at 0.6%, meaning that more money — 1.8% more than in December, to be precise — was spent on goods and services.
All that feverish inflation makes it almost certain that the Fed will continue hiking interest rates —possibly beyond its target of 5.25%, as the Fed's Mester told CNBC's Steve Liesman — and for longer. As you might expect, markets reacted badly to the news. The two-year Treasury yield climbed to a 16-year high of 4.814%. Both the Dow Jones Industrial Average and the S&P 500 dropped 1%, while the Nasdaq Composite sank 1.7%. It was the worst week for the major averages this year. The S&P closed 2.7% down, the Dow lost 3.0% and the Nasdaq 3.3%.
Some of those losses may not be entirely bad. Liz Ann Sonders, chief investment strategist at Charles Schwab, thinks that they're the markets skimming off speculative froth. But Jeffrey Roach, chief economist at LPL Financial, pointed out that underlying conditions are still turbulent. "Markets will likely stay choppy during these months where higher rates have yet to materially cool consumer spending," wrote Roach. In other words, the economy and the markets can't for the time being remain strong at the same time — something's got to give.
