Once again, hat tip to Torston Slok, chief economist at Apollo, for the great work he does in his research. The timely nature of this post following the U.S. Federal Open Market Committee (FOMC) and changes to the summary of economic projections at the recent FOMC meeting is timely.
The FOMC firmly believes that core PCE will return to its two per cent target by 2028 but has some concerns that inflation will remain elevated for the next year.
Let’s consider the facts, and not the opinions. Service sector inflation remains elevated, and goods sector inflation is clearly rising.
Tariffs are likely to negatively impact both (meaning rising inflation) over the near term. Service level inflation is now rising (or at least stopped falling) at a much higher base than the past decades.
Clearly the disinflationary forces of recent decades have come from goods. Going forward, less globalization has to increase the base rate from the levels seen in recent decades.
Globalization and shifting production to lower cost regions has been a major catalyst. This would be hard to debate even by the newest FOMC “Uber Dove” Stephen Miran.
If the base rate on both goods and services is elevated from recent decades, there is next to zero chance that the FOMC’s expectation of a return to two per cent core PCE is likely.
It’s a debate, but the probability is very low. We think the FOMC is trying to anchor to a lower number so that expectations remain lower. The psychology of inflation is important; it certainly was in the second wave in the 1970s.
Most components of the consumer price index (CPI) are rising and while an economic slowdown would cool this trend, the “Big Beautiful Bill” and regulatory stimulus are likely to be positive economic drivers over the next year. In this backdrop, it will be very hard for inflation pressures to cool enough to see the FOMC cut at a faster pace.
The last inflation cycle in the 1970s was initially a supply shock in the energy sector and had a second wave with the FOMC being too easy. History never repeats exactly, but it often rhymes. Is the trend to tariffs and less globalism enough of a catalyst to create the second wave?
I wish I knew, but it is something that is on my front burner. One thing is certain; government debt, all over the world is at growth choking levels. For now, deficits (credit expansion) remain a tailwind, but if the FOMC cuts too aggressively, that would be the biggest mistake.
Far worse than seeing the labour market soften. The primary reason we have economic growth is credit expansion.
What does this mean for your portfolio? Do not go out and sell your stocks but recognize that equities are priced for perfection.
We like Buffer ETFs that help manage the risk/return better and keep you invested in the case that markets continue to melt up under the AI boom.
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