Inflation Continues To Cool, But Here’s What It Doesn’t Mean

Inflation Continues To Cool, But Here’s What It Doesn’t Mean
Stéphane Renevier, CFA

8 months ago2 mins

What just happened?

Core inflation (economists’ favorite measure as it excludes the more volatile items like food and energy) rose just 0.4% in March, compared to the month before, in line with what was expected and encouragingly less than the previous monthly increase of 0.5%. But those prices were still 5.6% higher than the year-earlier levels.

That “core” rate was uncharacteristically hotter than the “headline” all-items inflation gauge, which rose just 5% in March compared to the year earlier, thanks to a dramatic fall in energy prices, which had skyrocketed last year when Russia invaded Ukraine.

In terms of components, it’s housing costs – the most lagging indicator of all – that contributed most to the rise in prices this month. And you can think of that as reassuring, as this component is expected to cool significantly in the coming months as higher mortgage rates continue to bog down the housing market.

Markets cheered the news, with bond yields and the US dollar falling, and stocks rallying, indicating that investors are now more relaxed about inflation risks and expect the disinflation trend to continue.

What does it mean?

This reading served up further evidence that the Federal Reserve’s (the Fed’s) now yearlong series of aggressive interest rate hikes is having the intended effect: reining in the country’s red-hot inflation, which peaked above 9% last summer.

Still, it’s not job-done: inflation is still far from the Fed’s 2% target, and with monthly core inflation rising at 0.4% and many components still rising at an elevated pace, inflationary pressures are clearly still very much present in the economy. What’s more, the recent cut in oil production by OPEC+ may push inflation higher again. This reduces the chances of a dramatic shift in the Fed’s policy.

As for inflation, it’s heading in the right direction, but you may not want to get too excited just yet. The market expects inflation to return below 3% early next year (purple line), which would leave it very close to the Fed’s 2% long-term target. But it’s not likely to come easily: falling inflation is also likely a sign that the economy’s struggling beneath the surface. Now, some will see that as good news for stocks, potentially elevating the chances of future rate cuts (which would boost stocks valuations), but it may be less positive over the medium term if slower growth translates into lower profits.

So, in the meantime, it may make sense to consider adding assets to your portfolio that are likely to benefit from lower rates and potentially meager growth, like gold and Treasury bonds, and potentially the riskier, more crash-prone bitcoin.



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