'I'm Playing A Bit Of Defense': Experts React To 4.2% CPI Inflation

The SPDR S&P 500 ETF Trust SPY traded lower by 1.7% on Wednesday after the U.S. Consumer Price Index rose 4.2% in the month of April, its largest increase since September 2008.

April’s inflation increase exceeded consensus economist estimates of 3.6%.

Fed Not Alarmed: Federal Reserve vice chairman Richard Clarida said investors should expect inflation numbers to temporarily rise further in coming months as the U.S. recovers from the pandemic. However, Clarida said inflation should moderate in the second half of 2021.

“These one-time increases in prices are likely to have only transitory effects on underlying inflation, and I expect inflation to return to—or perhaps run somewhat above—our 2% longer-run goal in 2022 and 2023,” Clarida said.

The headline inflation number certainly seemed to spook investors, who are concerned the Fed will be forced to raise interest rates sooner than expected to cool down an overheated economy.

On Wednesday, the bond market was pricing in a 9% chance the Fed will raise interest rates by the end of 2021, according to CME Group.

Related Link: 3 Top Bank Stock Picks For 'Goldilocks Inflation' Cycle

Danger Of Hyperinflation: Chris Zaccarelli, Chief Investment Officer for Independent Advisor Alliance, said the question for investors isn’t if inflation returns, it’s how and when the Fed will act to keep it contained.

“If they time everything perfectly – and we would suggest that even they realize how difficult that would be to do – then inflation won’t rise far above 2%, but otherwise we are headed higher than that and ultimately the Fed will need to tighten monetary policy, which is what will likely cause the next recession and end this bull market,” Zacarelli said.

How To Play It: Nancy Davis, founder of Quadratic Capital Management, said investors need to start thinking about how to diversify their portfolios and prepare for inflation levels to remain above the Fed’s 2% target.

“If bond yields rise, as the market prices in higher inflation expectations and investors demand higher yields on bonds, bond holders could see price drops in parts of their portfolios that they thought were safe,” Davis said.

Former hedge fund manager Whitney Tilson said inflation is the macroeconomic metric he is monitoring most closely these days.

“I'm playing a bit of defense by sitting on 22% cash and taking some profits among my biggest winners,” Tilson said.

He also noted investors are rotating from growth stocks to value stocks, which he said was another smart thing for investors to do at this point.

Benzinga’s Take: Long before inflation levels started to rise, the Fed said it intended to allow inflation to at least temporarily exceed its 2% long-term target to make up for years of inflation levels below that target. A 4.2% inflation level is far from alarming in itself, particularly off of pandemic comps. However, investors will need to continue to monitor inflation in coming months to make sure it doesn’t rise to potentially dangerous levels.