Inflation: a headache for the FED

Economic figures are more resilient than expected, which may become a headache for the FED to achieve its inflation targets. We are talking about possible changes to rate cut expectations in terms of Fed decisions. The fight against inflation has not yet been completely successful. This is why we are going to look together at the possibilities of having inflation that is more resilient than expected.

Expectations of a rate cut

At the end of 2023, we had several data which highlighted forecasts for several rate cuts. Traders ended up betting on a pivot by the FED for 2024. We can see the different expectations of cuts in the chart below:

inflation, FED, rebound
Source : CMEgroup

All these anticipations led to an easing of rates on the bond market, which translated into relief on the financial markets. It is through this great opportunity that the financial markets outperformed during the last quarter of the year and at the start of the year.

The objectives of the fed

The Fed’s primary mandate is price stability. Therefore, its objective is to bring inflation towards 2% via its monetary policy restrictive. His second mandate is full employment. Therefore, if the job market remains fairly resilient, the Fed will continue to focus on price stability, i.e. inflation. For now, the Fed needs to be more convinced that the measures it has taken so far have been successful. They do not want to get too carried away and confirm several rate cuts since they remain cautious.

Generally, the Fed prefers to rely on the PCE core index. We can see that the CORE inflation data is close to the target of 2% on an annualized rate of 3 months and 6 months. However, the annualized rate from year to year is close to that of the CPI, i.e. 3%. The “core” version does not include more volatile components like energy and food.

inflation, FED, rebound
Source : Twitter

Even if the slowdown in growth during 2023 had the effect of slowing inflation towards 3%, the easing of rates following expectations of a decline for the year 2024 had the opposite effect. The easing of rates has made financial conditions more comfortable. Therefore, the latest economic figures have demonstrated some resilience which may lead to some inflation resilience subsequently.

Obviously, this does not mean that inflation should rebound to the same levels as previously, but it does mean that it risks persisting above 3% (CPI). So the real question is not whether the FED will cut rates, but rather how quickly it will do so if it does. Indeed, too rapid an easing could lead to a rebound in inflation. We could see the effects of the easing of rates on the bond market.

Rate probabilities

You should know that the data on projections and forecasts of increases, decreases or pauses in rates are quite variable. It all depends on the variation in economic data in parallel and the lagged effects of the Fed’s communication and the effects of monetary policy. Just like in 2023, the fed should make rain or shine.

inflation, FED, rebound
Source : Twitter

Until then, inflation showed some form of slowdown. However, since the easing of rates, we have had an improvement in financial conditions which has probably led to an improvement in the economy. This is how we went from a pause of several months (to see the delayed effects of the rise in rates), towards a forecast of several reductions planned to end today in reducing the probabilities of a reduction for the March.

inflation, FED, rebound
Source : CMEgroup

Waves of inflation

Inflation is quite cyclical, meaning we have waves of acceleration and waves of slowdown. We can highlight the last waves of inflation during the 1970s and compare with the situation today.

inflation, FED, rebound
Source : Twitter

Obviously, the visual comparison is similar but the situation is completely different from that of the 70s. For example, the level of debt is different. The demographic situation is different.

The 3% level, which seems to be a fairly resilient threshold, could become the new 2%. Having a high fiscal deficit could contribute to having to maintain a high interest rate to offset the risk of defaulting on a large debt. And high rates could lead to inflation on mortgages as homeowners have to renew with a higher rate.

Economic Growth

There are several data that can preserve a certain level of inflation above 3%. First, we can see that GDP has performed more than 3% for the last two quarters. This kind of situation demonstrates a certain economic resilience.

inflation, FED, rebound
Source: Twitter

On the other hand, we can also say that the Conference board’s leading indicator indicates a slight rebound. Even though the level is still in the contraction zone, we can see that this rebound is reflected in the economy.

inflation, FED, rebound
Source: Conference board

The composite PMI brings together data on both goods and services. We see a rebound and a return to zone 50 (expansion zone).

inflation, FED, rebound

An improvement at the consumer level

On the consumer side, we have a strong upward variation that comes from the consumer sentiment satisfaction survey.

inflation, FED, rebound
Source : Twitter

A job market and a resilient economy imply wage growth which will maintain consumption.

The fiscal deficit

The fiscal deficit can also result in stimulus because it ensures the spending and aid necessary to stimulate the economy. We can see in the graph below the significant increase in the fiscal deficit.

inflation, FED, rebound
Source : Twitter

Raw materials

Commodities are quite correlated to the change in inflation. Moreover, raw materials have strongly contributed to the fall in inflation. We can see this in the graph below when we compare the two data.

inflation, FED, rebound
Source : Tradingview

From a technical point of view, we can see that we have a fairly resilient threshold and support level on the chart. As long as we stay inside the framed side area. To put pressure on a drop in inflation below 3%, there would need to be a downward break in commodities which could translate into an acceleration of the economic slowdown.

inflation, FED, rebound
Source : Tradingview

A revival of China

A Chinese revival could subsequently generate inflation globally. We know that China’s central bank is trying as hard as possible to revive the Chinese economy by injecting a lot of liquidity. This will eventually have an effect on the economy, and this could subsequently lead to inflation.

inflation, FED, rebound
Source : Linkedin

Conclusion

If all this data remains strong enough, it could lead to more resilient inflation than expected. We are talking here about resilience from the moment when inflation persists around 3-4%, which puts aside forecasts towards 2%. For a more aggressive rebound in inflation, economic data would need to rebound even more.

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