The S&P 500 has experienced a remarkable surge of over 25% since the late-October lows. This rally coincided with heightened investor optimism regarding a swift decline in inflation rates and anticipated aggressive rate cuts by the Federal Reserve.
However, recent indicators suggest a potential slowdown in the pace of inflation decline, with hints of a reversal. The last two consumer price index reports have hinted at this trend.
While seasonal factors may have influenced recent CPI readings, significant price hikes in sectors beyond the Fed’s control, such as auto and health insurance, have contributed to this narrative.
Thursday’s producer prices report further fueled concerns, with both the headline reading of a 0.6% increase on the month and the core measure of wholesale inflation surpassing expectations.
These developments have raised flags across various sectors, posing potential risks to both stocks and bonds in the short term.
Measures to Watch
Consumer inflation expectations, as gauged by the New York Federal Reserve, have surged when considering the outlook for the next three to five years.
Similarly, the New York Fed’s Multivariate Core Trend model, a refined metric of underlying inflation, has trended upward. It now projects core inflation at 3.04%, compared to a low of 2.46% recorded in November 2023.
Adding complexity to the situation is the recent uptick in both oil and gasoline prices. West Texas Intermediate crude oil futures surpassed $80 per barrel on Thursday, driven by Ukraine’s escalating attacks on Russian oil refineries, ongoing unrest in the Middle East, and OPEC’s persistent production cuts.
Gasoline futures, which had dipped below $2.00 a gallon in December 2023, are now hovering around $2.69 a gallon. When combined with sustained high grocery costs, consumers are likely to feel the impact of these two critical prices in the coming weeks and months.
One bright spot in the energy sector has been the continual decline in natural gas prices, crucial for power generation and home heating or cooling. Natural gas prices have remained historically low, offering some relief on this front.
However, other commodity prices, including copper and corn, have also surged in recent weeks, jeopardizing the trend of prolonged disinflation observed over several months.
This situation may prompt the Federal Reserve to postpone any rate cuts until the recent price surge subsides, potentially affecting plans for a rate reduction in May or June.
Could Slowing Growth Temper the Bump in Prices?
It’s conceivable that the current price surge could be a transient occurrence, and as economic growth naturally decelerates, these pressures might be alleviated.
The Atlanta Federal Reserve’s GDPNow forecast indicates first-quarter growth at an annual rate of 2.3%, a decrease from previous estimates.
Additionally, there have been downward revisions in payroll growth for December and January, signaling some slackening in the labor market. This trend could signify a forthcoming slowdown in economic growth.
Such a scenario could prompt a return to lower inflation levels and potentially accelerate the timeline for anticipated rate cuts by the Federal Reserve.
While I maintain my belief that inflation will continue to decline, the Fed will enact three rate cuts this year, and growth will moderate, preserving the “Goldilocks scenario” for the rest of 2024, it’s imprudent to disregard current market signals, at least in the short term.
Renowned economist John Maynard Keynes famously stated, “In the long run, we are all dead,” underscoring the importance of short-term vigilance for changes in this year’s economic outlook.
There’s another well-known adage: “When the facts change, I change my mind. What do you do, sir?”
“While I’m not yet prepared to alter my perspective, I remain receptive to the possibility. Market indicators suggest that I should be.”
