Surging inflation fears sent markets tumbling and Fed officials scrambling

A sign advertising units for rent is posted outside a Manhattan building on April 11, 2024 in New York.

Spencer Platt | Getty Images

The first data is available on the evolution of inflation during the first three months of 2024, and the news so far is not good.

Choose your poison. Whether it’s checkout prices or wholesale input costs, even though inflation is below the blistering pace of 2022, it doesn’t appear to be going away any time soon. Future expectations are also on the rise.

Investors, consumers and policymakers — even economists — were caught off guard by continued price pressures into early 2024. Stocks collapsed Friday as the Dow Jones Industrial Average sputtered nearly 500 points, falling 2.4% over the week and losing nearly 500 points. all his earnings for the year.

“Fool me once, shame on you. Fool me twice, shame on me,” Harvard economist Jason Furman told CNBC this week. “We’ve now had three straight months of higher draws than anyone expected. It’s time to change the way we think about things going forward.”

There is no doubt that the market has been forced to radically change its thinking.

Even import prices, an otherwise minor data point, contributed to this narrative. In March, it recorded its largest three-month increase in about two years. All of this was a real headache for the markets, which saw heavy selling for most of the week before really going off the rails on Friday.

As if all the bad inflation news wasn’t enough, a Wall Street Journal article published Friday indicated that Iran planned to attack Israel in the next two days, adding to the cacophony. Energy prices, which have been a major factor in inflation figures over the past two months, have risen on signs of further geopolitical turmoil.

“You can take your pick. There are a lot of catalysts” for Friday’s sell-off, said market veteran Jim Paulsen, a former strategist and economist at Wells Fargo and other companies who now writes a blog for Substack called Paulsen Outlook. “More than anything, it only depends on one thing, and if it’s going to happen, it’s war between Israel and Iran. … It just gives you a great sense of instability. “

Great hopes dashed

In contrast, early in the year, markets saw a dovish Fed willing to cut interest rates early and often – six or seven times, kicking off in March. But faced with persistent data each month, investors have had to recalibrate, now anticipating only two reductions, according to futures market prices which assume a non-zero probability (around 9%) of no reduction this year.

“I would like to see the Fed be able to cut rates later this year,” said Furman, who served as chairman of the Council of Economic Advisers under former President Barack Obama. “But the data just isn’t anywhere close to being there, at least for now.”

This week has been filled with bad economic news, with literally every day bringing a new dose of inflation reality.

It started Monday with a New York Fed consumer survey showing that expectations for rent increases over the next year rose dramatically, to 8.7%, or 2.6 percentage points. percentage more than the February survey. The outlook for the costs of food, gasoline, medical care and education has also increased.

On Tuesday, the National Federation of Independent Business showed that its members’ optimism had reached an 11-year low, citing inflation as their top concern.

Consumer prices were higher than expected on Wednesday, pointing to a 12-month inflation rate of 3.5%, while the Labor Department reported Thursday that wholesale prices posted their biggest increase in one year since April 2023.

Finally, a report released Friday indicated that import prices rose more than expected in March and recorded the largest three-month increase since May 2022. Additionally, JPMorgan Chase CEO Jamie Dimon warned that “ persistent inflationary pressures” posed a threat to the economy. and business. And the closely watched University of Michigan consumer confidence survey came in below expectations, with respondents also raising their inflation outlook.

Always ready to cut, one day

Fed officials took note of the higher numbers but did not sound the alarm, as most said they still planned to cut rates later this year.

“The economy has come a long way toward better balance and toward our 2 percent inflation goal,” New York Fed President John Williams said. “But we have not yet seen the full alignment of our dual mandate.”

Boston Fed President Susan Collins said she sees inflation “sustainably, if unevenly” returning to 2% as well, but noted that “it may take longer than I think.” had imagined before” for this to happen. Minutes released Wednesday from the Fed’s March meeting show officials are concerned about rising inflation and are looking for more convincing evidence that it is on a steady downward path.

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While the consumer and producer price indexes have captured the market’s attention this week, it is worth remembering that the Fed’s attention is elsewhere when it comes to inflation. Policymakers instead track the personal consumption expenditures price index, which has not yet been released for March.

There are two key differences between the CPI and PCE indices. Primarily, the Commerce Department’s PCE adjusts for changes in consumer behavior, so if people replace, say, chicken with beef due to price changes, that would be reflected more in the PCE than in the CPI. Additionally, PCE places less emphasis on housing costs, an important consideration as rent and other housing prices remain higher.

In February, the PCE figures were 2.5% for all commodities and 2.8% excluding food and energy, the “baseline” number that Fed officials watch most closely. The next version won’t arrive until April 26; Citigroup economists said current tracking data points to a slight decline in the core to 2.7%, better but still far from the Fed’s target.

Add the signals

Additionally, there are plenty of other signals that show the Fed still has a long way to go.

The so-called sticky CPI, as calculated by the Atlanta Fed, rose slightly to 4.5% year over year in March, while the flexible CPI jumped a percentage point, but at only 0.8%. The hard-priced CPI covers items such as housing, auto insurance and medical care services, while flexible prices focus on the prices of food, energy and vehicles.

Finally, the Dallas Fed cut the average PCE, which gives extreme numbers on both sides, to 3.1% in February – again far from the central bank’s target.

A positive for the Fed is that the economy has been able to tolerate high interest rates, with little impact on the employment situation or growth at the macro level. However, there are fears that these conditions will not last forever, and signs of cracks are appearing in the labor market.

“I have long worried that the last mile of inflation is the hardest. There is plenty of evidence of nonlinearity in the disinflation process,” said Furman, the Harvard economist. “If that’s the case, it would take a decent unemployment rate to get inflation to 2.0%.”

That’s why Furman and others have pushed the Fed to rethink its single-minded commitment to 2% inflation. BlackRock CEO Larry Fink, for example, told CNBC on Friday that if the Fed manages to bring inflation down to around 2.8%-3%, it should “end the day and win.”

“At a minimum, I think getting to something that would round to 2% inflation would be very good – 2.49 rounds to two. If it stabilized there, I don’t think anyone would notice,” Furman said . “I don’t think they can tolerate an inflation risk above 3, though, and that’s the risk we face now.”

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