Hot Inflation Likely to Keep Fed on Ice
January’s report on consumer prices was a reminder that the fight against inflation isn’t over.
The Consumer Price Index was up a surprising 3% from a year ago, a slight acceleration from December’s 2.9% calculation. When measured month over month against December, prices rose 0.5%, adjusted for seasonality. Excluding food and energy costs, core CPI was up 3.3% and 0.4% for the year and month, respectively. Any way you slice it, progress on bringing down inflation to the Fed’s stated goal of 2% has stalled over the past few months. See the exhibit for further context.
Exhibit: Consumer Price Index, Change from a Year Earlier
Source: Bureau of Labor Statistics, The Wall Street Journal, Clayton Wealth Partners.
These latest numbers bolster the case for the Fed’s current wait-and-see approach. Fed Chair Jerome Powell and his colleagues are keen to avoid repeating the mistakes of their predecessors that eased policy too quickly and too much after seeing inflation improvement, only to see inflation reaccelerate as a result. Powell said as much in recent congressional testimony, stating: “We want to keep policy restrictive for now.”
The financial markets are buying it. As of this writing, markets are pricing in the Fed’s next quarter-point cut in June or July, with about a 50% chance that’s it for 2025. (In September 2024, the Fed penciled in four quarter-point cuts in 2025).
All of this as the new administration moves forward with tariffs as part of its trade policy, which as we’ve written before, could potentially lead to inflation acceleration.
For now, financial markets and the economy are taking everything in stride. We remain fully allocated and broadly diversified, which is increasingly important in periods of elevated uncertainty. What does seem clear is that inflation will once again be an important topic for investors in 2025.
Bullish
- The Fed has made good progress in reducing inflation since 2022.
- The Fed is now in an easing cycle.
- Consumer spending seems to be supported by a healthy labor market, household investment income, and the wealth effect.
- The most attractive yields for fixed income and cash in years.
- Consumer and corporate balance sheets generally remain healthy.
Bearish
- Slowing global economic growth.
- Housing affordability remains at a decades-low.
- Leading indicators of unemployment are generally trending down.
- Delinquency rates on consumer loans are rising.
- Russia-Ukraine war, Middle East conflict, and other geopolitical concerns.
- China is experiencing a growth recession, with deflation fears growing.
- Federal debt and deficits have ballooned.