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Markets putter along, boosted by infrastructure deal but hampered by inflation

Wall Street managed to nab a minor win this week as two words dominated financial headlines: infrastructure and inflation.

MANHATTAN (CN) — Wall Street closed out the week with a minor win, helped by the passage of the $1 trillion infrastructure package in the Senate but hindered by persistent inflation and louder calls for the Federal Reserve to back out of the market.

By the closing bell on Friday, the Dow Jones Industrial Average had picked up an additional 307 points since last week. The S&P 500 and Nasdaq had worse outings, though, gaining only 32 points for the former and losing 13 points for the latter.

The big news for investors was the passage of the $1 trillion infrastructure legislation out of the Senate, which caused markets to pick up slightly on Tuesday. Wall Street was pleased the bill made it out of the Senate, though the future of the bill remains in flux: some moderate Democrats are now threatening not to pass the Biden administration’s significantly larger $3.5 billion budget unless the infrastructure bill passes first.

That good news was quickly overshadowed, however, by the same bugaboo that has pestered Wall Street and consumers both over the last few months: inflation.

Earlier in the week, investors noted that the Consumer Price Index increased 0.5% in July, or 5.4% for the past 12 months. While the numbers once again were notably high, they were not as high as many had expected, given the 0.9% CPI increase seen in June.

Several data points saw big jumps. Gasoline prices gained 2.4% compared with June, while new vehicle prices increased 1.7%. Used car prices, which had leapt up 10.5% in June, gained only 0.2% in July. Peter Boockvar, chief investment officer at Bleakley Advisory Services, says that the increase of rent has not yet been fully baked into the data though car prices might be slowing.

“The cost of housing within the government numbers have a lot of catching up to do with reality, and thus this inflation story is going to continue so don’t rest easy,” he wrote to investors on Wednesday. “The problem also here is that inflation is running faster than wages, so we have a drop in REAL wages, which is economically contractionary and AGAIN why stable prices is the precursor to strong growth and employment.”

A similar report by the Bureau of Labor Statistics shows that real earnings dropped 0.1% in July, after previously dropping 0.5% in June. Real hourly earnings have fallen since December, when they gained 0.8%.

Boockvar remains skeptical about the BLS data showing primary residence rent increased only 0.2% last month. “So assume now that the big rent increases within the BLS data will only be playing catch up in the quarters to come because nowhere in real life were rents up just 0.2% in July from June and up by 1.9% year over year,” he wrote. He added that Apartment List states rent is up 11% since January.

Even those who are less concerned about inflation, such as Andrew Hunter, a senior U.S. economist at Capital Economics, think high prices will remain a bit sticky. “Overall, the July data suggest that the initial burst of stronger inflation is now fading, but it is still much too soon to dismiss the risks of a more prolonged period of higher inflation over the coming years,” he wrote.

Hunter also pointed to rent prices, which account for more than a quarter of total CPI, as proof that “lasting price pressures are continuing to build.”

As a result of the persistent inflation, many experts believe the Federal Reserve is on track to begin tapering its bond-buying program and possibly raise interest rates in early 2022. The Fed has repeatedly stated it wants to see an average 2% inflation over a sustained period of time before it tinkers with its aid programs.

“We suspect that we have passed the peak for the annual rate of inflation,” wrote James Knightley, chief international economist at ING. “Nonetheless, we are not as optimistic as the Federal Reserve in thinking that we will quickly get back down to the 2% target area.”

As do many other experts, Knightley worries that housing costs remain a big upside threat to the economy, adding that that will be “the story to watch” during the second half of 2021. “Given this backdrop we expect U.S. headline inflation to stay above 4% through [the first quarter of 2022] with core inflation unlikely to get below 3% until the summer of next year,” he wrote.

Some central bank governors and presidents already are calling for tapering. Earlier this week Kansas City Federal Reserve Bank President Esther George said tapering should begin soon. “I support bringing asset purchases to an end under these conditions,” she told members at a National Association for Business Economics forum.

Dallas Fed President Robert Kaplan also has been on record saying tapering should begin in October. Fed Chair Jerome Powell has said the central bank would give advance notice to markets before any decision on tapering or interest rates.

While inflation has been weighing on the Fed’s decision, consumer sentiment also may play a part. In the University of Michigan’s preliminary consumer sentiment index numbers released Friday, the index fell several points to 70.2, the lowest mark on the index since 2011. The index has dropped steadily since April, when it stood at 88 points.

“Over the past half century, the Sentiment Index has only recorded larger losses in six other surveys, all connected to sudden negative changes in the economy,” Richard Curtin, the survey’s chief economist, said in a statement. “In the months ahead, it is likely that consumers will again voice more reasonable expectation, and with control of the Delta variant, shift toward outright optimism.”

Optimism is in shorter supply, however, in the small-business community. The National Federation of Independent Business’s small business optimism index fell 2.8 points last month as sales expectations plummeted by the most in seven months. In June, the index had hit its higher point since last October.

The percentage for small businesses planning to raise prices remains at 44%, a historically high number, while a similar record of firms — 49% — say they still have difficulty finding qualified workers, up three points from the prior month.

Follow Nick Rummell on Twitter.

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