Fed Walking a Fine Line as Inflation Remains Stubborn
Key Takeaways:
- Inflationary pressures remain elevated.
- Service prices contributing the most to headline gains.
- Fed walking a fine line by getting dovish too soon and reigniting inflation.
- Rate cut expectations slashed from six to three since beginning of year.
- Rates to stay higher for longer amid increased pressures.
Last week, investors absorbed hotter-than-expected inflation data on both a month-over-month and year-over-year basis. The elevated inflation readings further call into question if the Fed will be able to cut rates anytime soon. The inflation reading was paired with the Federal Reserve’s March meeting minutes, which signaled, “participants... expressed the view that recent data had not increased their confidence that inflation was moving sustainably down to 2%.”
In this weekly, we wanted to analyze where pricing pressures stand in relation to how they typically grow on an annual basis (over the past 30 years) and how they grew in the year leading up to the pandemic. Then we looked at how prices have grown since the pandemic through last month (annualized basis). As can be seen in the table, prices are increasing at a faster annualized rate across various categories compared to the 30YR annual average. Energy prices have increased on geopolitical tensions in the Middle East and worries of global supply shortages. Food prices, both at home and away from home (i.e., restuarants) are significantly higher and are harming families. Services inflation is growing at an above average pace and is considered “sticky.” For example, auto insurance is growing more than double what the historical average has been.Bottom Line:
Inflation remains a major issue. Across all major areas of inflation that we analyzed, the annualized rate since the end of the pandemic is exceeding the past 30 year average and well above what we were accustomed to before the pandemic. The progress the Fed has made on inflation was the easy part (supply chain repairs) but the Fed needs to be more clear to investors that we are not near where we need to be. Typically, truly tackling inflation is not a smooth path and comes in waves. If the Fed continues with mixed messages about rate cuts, they can inadvertently fuel inflation as consumers spend with the anticipation of lower rates. In addition, price to earnings multiples across select sectors (e.g., tech) are too high given the expectation that inflation will take longer to reach the Fed’s 2% target. While there are three rate cuts priced in the futures market for 2024, we think one or two would be more likely and not until 2H24.