Despite coming in hotter-than-expected, February’s inflation report does not rule out the Federal Reserve starting to cut interest rates in the summer, some market watchers believe.
Tuesday’s Consumer Price Index (CPI) reading showed prices increased by 0.4% month-over-month and 3.2% in the 12 months to February, ahead of the 0.3% and 3.1% gains expected.
Core inflation, which excludes the more volatile food and gas segments, increased by 0.4% over the previous month and 3.8% over the last year. Both were above expectations of 0.3% and 3.7%, respectively.
Bank of America analysts see the data as continuing to support their view that a rate cut cycle will start in June.
“We view the underlying details as largely favorable for our outlook for further disinflation as the miss relative to our expectations came from surprise increases in core goods prices, while services inflation decelerated,” they wrote in a note to clients.
“We doubt deflation in core goods prices has ended and, in turn, view softer services inflation as a favorable development.”
Other analysts were not as optimistic.
Truflation head of product Oliver Rust believes the data has shown the US is turning into an era of stagflation, the reacceleration of inflation amid slowing economic growth, which will result in interest rate cuts being put off for longer than expected.
He said it was particularly concerning the increased prices were being driven by the shelter category as household debt is at a new record high of $17.5 trillion.
“Against this backdrop, the Fed now finds itself in a precarious position. It has indicated to the markets that rate cuts are coming in 2024, and this may indeed be necessary to stop consumers from defaulting on their debt,” he said. “However, cutting rates when inflation is reaccelerating is likely to only exacerbate matters.”
Market volatility, caution expected
The three major stock indexes traded higher at noon on Tuesday following the inflation report, with the Nasdaq adding 1.1%, the S&P 500 up 0.8% and the Dow Jones up 0.5%.
But investors should brace for volatility amid a potential delay in rate cuts from the Fed, deVere Group CEO Nigel Green warned. He believes the Fed could delay cutting rates to the third quarter of the year.
“As the markets are seemingly already pricing in a rate cut in the summer, should there be a pushback against this expectation, as we now believe there will be, we’ll see increased volatility across financial markets,” Green said.
“The uptick in the core PCE index [in January] inevitably raises concerns about the potential repercussions of inflationary forces, hinting that the surge in prices might compel the US central bank to reassess the timing of interest rate reductions.”
XTB research director Kathleen Brooks sees financial markets trading with a cautious tone in the days leading up to the Fed’s meeting next week.
“US stocks have whipsawed since the release; however, markets have been able to rally since the hotter than expected January inflation print, and we don’t think that the February number will knock the rally in stocks in the short term,” she said.