Is the Fed’s battle to contain inflation finally done?
The market seems to think so. Recent comments from multiple Wall Street firms and economists suggest this week’s rate hike will be the last one we see this year. After this week’s quarter-point rate hike, Fed Chair Powell acknowledged that inflation has proven resilient, leaving a September rate hike on the table. Meanwhile, the yield on the 10-year Treasury has fallen from its recent high.
Our view: While inflation remains on a downward trend overall, the path lower could take longer than some think. In part because the trend of favorable comparisons to prices last year is set to reverse. That means the annual inflation rate comparisons for the second half of 2023, as compared to the second half of 2022, will be far less striking than what we saw earlier this year.
The result: Don’t be surprised to see an upswing in the headline inflation rate over the next few months.
Consider, for example, that month-over-month headline inflation has averaged 0.22% during the past three months. If that continues, the annual reported inflation rate will be back up to 4% in December—and close to 5% if the monthly inflation rate rises to 0.3% (see the chart).
Notice that even if prices are flat month-over-month, annual headline inflation will end the year higher than the Fed’s target.
All this makes the Fed’s job particularly tough from here on out—and will likely cause Chair Powell and company to be less convinced than the market that inflation will simply keep fading away. If so, interest rates may stay elevated for longer than investors expect—setting the stage for potential market volatility later this year.
In that environment, we believe it will be important for portfolios to have some protection measures in place—while, of course, maintaining the broad exposure to equities that (as the last nine months of returns have shown) is crucial to generating the returns investors need to reach their goals.
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