What happened
Shares of several banks and consumer-facing finance companies fell today after a key gauge for inflation came in hotter than expected this morning, sinking the broader market. The Dow Jones Industrial Index had fallen roughly 775 points as of this writing and the Nasdaq Composite was down more than 3.5%.
Shares of PayPal (PYPL -1.60%) had fallen nearly 6.4% at 11:50 a.m. ET today. Shares of the artificial intelligence lender Upstart (UPST -0.98%) traded nearly 6.7% lower, and shares of Wells Fargo (WFC 3.09%) were down 5.8%.
So what
Investors were anxiously awaiting new data from the U.S. Bureau of Labor Statistics' closely watched Consumer Price Index (CPI), which tracks prices across a variety of consumer daily goods and services. In May, the CPI rose 8.6% year over year, its highest increase since December of 1981. Economists had only been expecting an 8.3% increase. Furthermore, the new data put a hole in some investors' beliefs that inflation had peaked.
Image source: Getty Images.
Digging deeper into the report, prices in the energy sector rose close to 4% from the prior month and were up nearly 35% year over year. Within energy, fuel and oil prices climbed close to 17% from the previous month and are now up more than 106% year over year. Another large increase came in airfare, which saw prices rise 12.6% from April. New vehicle prices also grew 1% from April.
"It's hard to look at May's inflation data and not be disappointed," said John Leer, chief economist at Morning Consult, according to CNBC. "We're just not yet seeing any signs that we're in the clear."
This also means the Federal Reserve will not be able to take its foot off the pedal in its efforts to tame inflation, which involve making more aggressive hikes to its benchmark overnight lending rate and reducing its nearly $9 trillion balance sheet. Both of these initiatives could put pressure on equity prices.
PayPal will feel the pain if prices continue to rise and put pressure on consumer finances, which may slow consumer spending across its platform. Upstart could see some benefit if more consumers need to resort to debt to cover their monthly expenses, but the company's investors will also have a higher cost of funding and a recession could increase loan defaults as well. The company already lowered its revenue guidance for the year in its last earnings release. While Wells Fargo is expected to benefit from rising interest rates like most banks, too much inflation can sap up loan demand and also increase loan losses, especially in a recession.
Now what
The CPI report is exactly what investors were hoping not to see because it could mean that inflation is still on the rise, which will make it harder for the Fed to engineer a soft landing for the economy.
Interestingly, Citigroup Global Wealth Investments issued a note yesterday saying that it believes the worst of inflation is now over and that consumer prices will fall in 2023.
The new CPI data is certainly interesting because it continues to show the current strength of the economy. The labor market is still strong, and consumers seem to be spending through the high prices, although this seems as if it could be starting to slow down a bit.
Ultimately, I do think a recession is possible but that it could be a modest and short recession. I am bullish about Wells Fargo and PayPal at these levels but am taking a much more cautious approach to Upstart due to several unique parts of its business model.
