“Will Rising Inflation Return?”
While it might not feel like it because price levels are still high, broad inflation (i.e., the annual increase in prices) remains in a downtrend. In October, the year-over-year change in the headline Consumer Price Index (CPI) was 2.6%, significantly lower than its June 2022 peak of 9%. And as of today, conditions are in place for inflation to continue falling, albeit at a more moderate pace.
The exhibit shows the annual inflation of the three major components of CPI: goods, shelter costs, and services (excluding shelter). Each is roughly a third of the total CPI. Over the past year and a half or so, a big decline in goods inflation significantly contributed to lower total inflation. Shelter-cost inflation is still elevated, but it is set to continue to fall: The CPI calculation doesn’t give full weight right away to newly signed leases, where price pressures have been coming down. And finally, services inflation should continue to come in lower: Wages make up a chunk of services costs, and annual changes in compensation should keep moderating as the labor market continues to cool.
Exhibit: Components of CPI Inflation
Source: Bureau of Labor Statistics, Federal Reserve, Federal Reserve Bank of New York, Macrobond, Fidelity, Clayton Wealth Partners.
As we look ahead to a new year and new president, a couple of President-elect Trump’s policies may impact inflation, starting with trade tariffs. Tariffs are simply a sales tax that an entity pays to the U.S. Treasury Department as goods from another country cross the U.S. border. Tariffs are intended to protect local jobs and industries from international competition. Once the importing entity pays the tariffs, it has a choice: It can either absorb the extra tax, which would cut into its profit, or pass along the cost of the tariff to its customers by raising prices. In the latter case, that could put renewed pressure on goods inflation.
Immigration reform is another policy that could impact inflation. According to a July 2024 report from the nonpartisan think tank Pew Research Center, about 4.8% of the U.S. workforce in 2022 came from unauthorized immigrants. Their mass deportation could significantly re-tighten the labor market, potentially putting upward pressure on wages and, in turn, services inflation.
All of this is in theory, and much depends on the final details of the new administration’s policies: Could the threat of tariffs be a negotiating tool for our trade partners? To what extent will there be exceptions to tariffs? How many undocumented migrants will actually be deported? Finally, it’s important to keep in mind our economy is a very complex system; any inflationary headwinds from these policies could be offset by other aspects not discussed here. Regardless, we watch developments as they happen and adjust portfolios as necessary.
Bullish
- The Fed has made good progress in reducing inflation since 2022.
- The Fed is now in an easing cycle and looks to cut rates aggressively.
- The most attractive yields for fixed income and cash in years.
- A revised savings rate shows more cushion for consumer spending.
- Consumer and corporate balance sheets generally remain healthy.
Bearish
- Slowing global economic growth.
- Banks are tightening lending standards for consumers.
- 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, Israel-Hamas conflict, and other geopolitical concerns.
- China is experiencing a growth recession, with deflation fears growing.
- Federal debt and deficits have ballooned.