Inflation is remaining hotter than expected for longer than the Federal Reserve would like — and policy makers may have no one to blame but themselves, according to one economist.
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Trillions of dollars in household wealth have been created in the five months since Fed Chair Jerome Powell signaled that there would be no further interest-rate hikes this cycle — directly contributing to strong consumer spending that has kept inflation elevated, according to Torsten Slok, chief economist for Apollo Global Management in New York. Slok’s view is based on the combined value that’s been added to the S&P 500 index SPX and the Bloomberg Barclays U.S. Aggregate Bond Index.
Powell’s so-called dovish pivot was followed in December by Fed policy makers’ median projection for three quarter-point rate cuts in 2024, which “unleashed a dramatic easing in financial conditions,” Slok said via phone on Wednesday after the release of March’s surprisingly strong consumer-price index. The Fed’s 2022-2023 hikes are “being neutralized and overtaken by the stock market and the tightening in credit spreads,” among other factors, and “it’s very clear at this point that the momentum in inflation because of the easing of financial conditions is really strong,” Slok added.
Stocks have rallied over much of this year to new record highs, only to be interrupted by signs that the Fed’s work may not be done. On Wednesday, the Dow Jones Industrial Average DJIA finished with its third straight day of losses, down by 1.1% or 422.16 points, after March’s CPI report showed inflation rose sharply again. Treasurys sold off aggressively, handing 2- BX:TMUBMUSD02Y and 10-year BX:TMUBMUSD10Y yields their biggest one-day jumps respectively since March 27, 2023, and Sept. 22, 2022.
In March, Slok flagged the likelihood that no Fed rate cuts would be coming this year because of the simple reality that the U.S. economy isn’t slowing down. He did this at a time when fed-funds futures traders were still on board with roughly three quarter-point cuts by December. The Fed’s main policy rate target has remained between 5.25% and 5.5% since last July.
Only a few weeks ago, the possibility that the Fed might need to hike rates again was “completely unheard of,” Slok said. Now, the need for higher interest rates is part of an emerging debate — although Slok puts only a 25% chance on further rate hikes occurring because policy makers may want to keep waiting for the full impact of past actions to make their way through the economy.
Rising values on everything from stocks to home prices, along with cash flows into interest-paying fixed income, are responsible for a surge in consumer spending on restaurants, hotels, concerts and other entertainment that’s making it hard to contain price gains, according to the economist.
It’s too soon to conclude whether more rate hikes, or even a recession, is needed for the Fed to win its battle on inflation, he said. Meanwhile, Slok added, the entire Treasury yield curve still needs to adjust from here to a higher-for-longer environment on rates.
The story for equities is more complicated, he noted. On one hand, higher interest-rate expenses for companies are bad for earnings. On the other, higher rates are also being driven by stronger fundamentals.
“The net result would be that equities should be trading positively, but it all depends on the Fed being successful in getting inflation under control without a recession,” Slok said.
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