The Markets Don’t Heed the Fed’s Warnings. That Could Be Costly for Them.

Chico (far left) and the rest of the Marx Brothers: His ghost seems to live among bond traders.

Hulton Archive/Getty Images

Who are you going to believe, me or your own eyes? The ghost of Chico Marx seems to live on among bond traders, who continue to doubt the Federal Reserve’s resolve to continue its inflation fight into 2024.

While the odds of one more quarter-point increase in the federal-funds target at the Fed’s policy meeting on May 2-3 have become a near lock, markets keep pricing in rate reductions in 2023’s second half. That’s contrary to the best guesses of Fed Chairman Jerome Powell and his colleagues that the key policy rate will end the year at 5.1%, which implies no cuts after the May hike.

The decision to stay the course was set despite the Fed staff’s forecasting a mild recession later this year, according to the minutes of the most recent policy meeting on March 21-22, which were released this past week. In light of that, bond traders still look for the Fed to flinch. But inflation, while off from its four-decade peak hit last year, has stopped improving. And consumers aren’t being fooled by better year-over-year numbers resulting from the big 2022 jumps. They see price trends showing little improvement.

For instance, consumer prices showed a 5% increase in the latest 12 months, the Bureau of Labor Statistics reported this past week, down from the 9% year-over-year peak rise recorded in 2022. But the core CPI, excluding food and energy costs, was still 5.6% above the level a year earlier, and rose at a 5.1% annual clip in the latest three months. Alternative measures, such as the Atlanta Fed’s core “sticky prices,” rose at a 5.9% annual pace in that stretch, not much slower than the 6.5% in the past 12 months.

Consumers see inflation rising, not falling, in the coming 12 months, no doubt because of the recent leap in energy costs. Numbers from the University of Michigan, out on Friday, showed a jump in anticipated inflation for the year ahead to 4.6%, from 3.6% a month earlier. The New York Fed’s consumer survey found a similar rise in one-year inflation expectations, to 4.7% in March from 4.2% a month earlier.

Additional meaningful insights into price trends should come in the corporate earnings reporting season just getting under way, according to Ronald Temple, chief market strategist at Lazard Asset Management. While it might be too early to gauge the effects from the banking turmoil set off by the failure of Silicon Valley Bank, impacts of the Fed’s yearlong rate-hiking campaign should be evident in managements’ conference calls, he tells Barron’s. Cost pressures remain high, but companies have less ability to pass through further price increases. That points to slimmer profit margins.

Here’s how BCA’s editorial board answers the question of whom to believe: no Fed rate cuts with persistent inflation, while the S&P 500 index holds above 4000, not far from Friday’s close. Easing would come only with a meaningful break of 3500, they write in a strategy report. Sorry, Chico.

Write to Randall W. Forsyth at [email protected]

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