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January Inflation In The Spotlight

Written by: Frank Fazio

Recent market volatility has been mostly due to fears over rising inflation. This morning’s CPI report, a widely used measure of inflation, came in slightly ahead of expectations and did not alleviate these fears. For the month of January, CPI rose 0.5% versus an expected rise of 0.3%. Core CPI, which excludes volatile food and energy costs, rose 0.3% versus and expected 0.2%. On a year-over-year basis, Core CPI rose 1.8% versus and expected rise of 1.7%, which remains below the Federal Reserve’s stated target of 2%. Although higher than expected, these figures do not signal runaway inflation. Retail sales were also released this morning, and fell more than expected in January, with December’s data revised lower. Both reports weighed on stock markets to start the day, and caused the 10-year U.S. Treasury bond yield to increase to 2.88%.

Higher-than-expected inflation and weakness in retail sales in January are not an ideal start to the year when coupled with the recent bout of volatility. However, this morning’s data does not signal a compelling trend. Inflation pressures are certainly rising, which is to be expected with an economy growing at a 2.5-3% pace. However both headline and core figures do not suggest the pressure is growing at an alarming rate. Furthermore, the weakness in retail sales may be due to two factors, one being adverse weather in January at the start of the month, and the other could be attributed to a pause in spending after a strong Fourth Quarter.

It is important during this period of volatility to assess your tolerance for risk. We do not see this selloff as indicative of a larger downturn. Although we entered a market correction (10% decline) last week, the last three days of positive performance has taken markets out of correction territory. Given our expectation for higher yields over time, we remain underweight fixed income relative to equities and believe the probability of recession here in the U.S. remains low. We have been using recent volatility as an opportunity to put cash to work in client portfolios, and add to areas we believe have good long term growth prospects.