Unease About Continued High Inflation Dogs the Market

The stock market is uneasily anticipating Friday’s release of the Consumer Price Index for May. This comes amid talk that the Federal Reserve will go too far in its fight against rising prices and harm the economy.

While some on Wall Street think we have seen peak inflation, there’s also fear that the CPI will stay too high—meaning over 8%—for too long. Feared result: The Fed will keep hammering away and hiking rates, obliterating any chance of a soft landing for the economy.

The S&P 500 is down 0.6% today, following a rally off the slide that began in March. “The market finds itself between wanting to believe in the rallies but not believing that the Fed can negotiate a soft landing,” comments Quincy Krosby, chief equity strategist for LPL Financial.

The CPI posted an 8.3% rise for April, over the preceding 12 months. Projections on Wall Street are for 8.1% in May, a small slowing of the inflation pace. But painful price levels for food and fuel are expected to remain, meaning consumers will see very little relief.

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The Fed itself forecasts that inflation will end up at 4.3% for the year, before reaching 2.7% in 2023 and 2.3% in 2024 (these are for its preferred inflation gauge, which is slightly less than the CPI). “It may take longer than we like but I’m confident that we’ll use our tools to bring inflation down,” Powell said at his recent press briefing.

What if inflation remains stubborn? There are big questions about whether the Fed’s tightening campaign will go too far. Ray Dalio, founder of hedge fund powerhouse Bridgewater Associates, recently said that the “pain of that will become great and that will force the central banks to ease again.”

Precedent exists for such about-faces. The Federal Reserve halted its tightening in 2018 after economic indicators flagged, then lowered rates. The European Central Bank raised rates in 2011, yet was forced to do a 180-degree turn later that same year. The Bank of Japan hiked rates in 2006 and then had to reverse its course in 2008.

The city of Providence’s pension fund, which is among the most underfunded in the country, just got one step closer to approving $515 million in pension obligation bonds. A majority of voters cast ballots in favor of the mayor’s proposal to issue $515 million in bonds in a non-binding referendum. While the results do not give Mayor Jorge Elorza the authority to issue the bonds, they do help build his case to the state, whose approval he needs to issue the bonds.

The vote was split, with 30% voting against the proposal and 70% voting in favor. However, turnout was low: Only 4% of city residents voted.

Providence’s pension has a funded ratio of 22% and over $1 billion in unfunded liabilities.

Pension obligation bonds are essentially loans that the pension takes out with a fixed interest rate. The hope is that investment returns exceed the interest rate on the bonds, thus allowing the pension fund to increase its funded ratio. However, a recession or investment downturn could lead to the pension losing money on the bonds. Such was the case in Puerto Rico when it issued pension obligation bonds in 2008. While a total collapse like what occurred in Puerto Rico is unlikely to happen in Providence, according to experts,

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Public pensions have more than doubled their borrowing this past year, according to S&P Global. In 2020, the S&P rated $3 billion in public pension bond issuances. In contrast, the S&P rated $6.3 billion in public pension bond issuances between January 1 and September 15, 2021. However, as interest rates begin to rise again, bond issuances will likely decrease again.