Inflation is staying higher than expected for longer than expected — and policymakers may only have themselves to blame, according to an economist.
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In the five months since Fed Chairman Jerome Powell signaled there would be no more rate hikes this cycle, trillions of dollars in personal wealth have been created – a direct contribution to strong consumer spending that has kept inflation high, said Torsten Slok, chief Economist for Apollo Global Management in New York. Slok’s view is based on the combined value added to the S&P 500 index SPX and the Bloomberg Barclays US Aggregate Bond Index.
Powell’s so-called “easy about-face” was followed in December by Fed policymakers’ median forecast for three quarter-point rate cuts in 2024, which “triggered a dramatic easing in financial conditions,” Slok said by phone Wednesday after the surprise release of the March forecast strong consumer price index. The Fed’s rate hikes for 2022-2023 will be “neutralized and overtaken by the stock market and tightening credit spreads,” among other factors, and “it is very clear at this point that the inflation dynamics are really continuing due to easing financial conditions.” strong,” Slok added.
Stock markets rallied to new record highs for much of this year, but were punctuated by signs that the Fed’s job may not be done. On Wednesday, the Dow Jones Industrial Average DJIA ended its third straight day of losses, down 1.1%, or 422.16 points, after the March CPI report showed inflation had risen sharply again. Treasuries sold off aggressively, with 2- BX:TMUBMUSD02Y and 10-year BX:TMUBMUSD10Y yields delivering their biggest one-day jumps since March 27, 2023 and September 22, 2022, respectively.
In March, Slok pointed out that due to the simple fact that the US economy is not slowing down, it is likely that there will be no Fed rate cuts this year. He did so at a time when Fed funds futures traders were still on board with cuts of about three-quarter points through December. The Fed’s key interest rate target has been between 5.25% and 5.5% since July last year.
Just a few weeks ago, the possibility that the Fed would have to raise interest rates again was “completely unknown,” Slok said. Now the need for higher interest rates is part of an emerging debate – although Slok puts the likelihood of further rate hikes at just 25%, as policymakers may want to continue to wait for the full impact of past measures to ripple through the economy.
Rising values for everything from stocks to home prices, as well as cash flows into interest-bearing fixed income securities, are driving a surge in consumer spending on restaurants, hotels, concerts and other entertainment, making it difficult to contain price increases, economists said.
It’s too early to conclude whether more rate hikes or even a recession are needed for the Fed to win its battle against inflation, he said. Meanwhile, Slok added, the entire government bond yield curve still needs to adjust to a longer-term higher interest rate environment from here.
With stocks, the situation is more complicated, he noted. On the one hand, higher interest expenses for companies have a negative impact on earnings. On the other hand, higher interest rates can also be attributed to stronger fundamentals.
“The net result would be that stocks should trade positively, but it all depends on the Fed being able to get inflation under control without causing a recession,” Slok said.