US inflation will be back in focus this week, following Friday’s stronger-than-expected 1Q employment cost index, which showed annualized growth of 2.7%, the fastest pace of increase since 4Q 2008. The Federal Reserve’s preferred inflation measure, the Personal Consumption Expenditure core price index (PCE), will be released later today and is expected to close in on the central bank’s 2% target. Consensus expectations are for an annualized increase of 1.9% in March, up from 1.6% in February.
But, while the forecast month-on-month change is relatively sharp, we don’t expect the Fed to change from its current pace of interest rate hikes:
- The jump in core PCE is due to well-flagged base effects, with last year’s changes in wireless phone service costs dropping out of the calculation.
- The Fed doesn’t expect inflation to move much above its 2% target. The median prediction of Fed officials from the central bank’s latest economic projections released in March sees inflation at 1.9% in 4Q 2018, and at 2.1% in both 4Q 2019 and 4Q 2020.
- Even if inflation does move above the 2% target, Fed officials have offered reassurance that an overshoot to 2.2–2.3% does not constitute overheating, and would be unlikely to prompt a faster pace of tightening.
So we expect the Fed to stick to a “speed limit” of one 25-basis point hike per quarter this year. We will be monitoring the Fed’s language in the statement from this week’s Federal Open Market Committee meeting for any signs of greater concern on inflation. But we see only a 10–20% chance of the fed funds rate rising above 3% in the coming six to 12 months due to accelerating inflation or wage growth. We remain overweight global equities and overweight 10-year US Treasuries.
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