Inflation in the US should decelerate but it will not be a smooth process, experts have warned, with the Federal Reserve facing a difficult prospect of balancing a fragile economy with rising prices.
The consumer price index for February rose 0.4% compared to a 0.5% rise last month and 6.0% on a year-on-year basis versus 6.4% in January.
Nathaniel Casey, investment strategist at Evelyn Partners said the inflation data provided a mixed picture with regards to goods prices, core services and shelter.
He added: “Goods prices have largely moderated despite an acceleration in household furnishings’ prices and although still elevated, shelter inflation is expected to decelerate over the coming year (based on recently signed rental leases).
“That said, core services excluding shelter which accounts for more than half of consumer expenditure remains stubbornly high, with Fed chair Powell acknowledging inflation in this sector needs to fall before we see price stability. “
Pictet Wealth Management expects the US personal consumption expenditures (PCE) inflation to end the year at 3.4%, down from 4.7% in January but above the 2% inflation target.
Frederik Ducrozet, head of macroeconomic research at the firm, said: “Rental disinflation (already evident in industry measures) should start passing through to readings for shelter inflation around the summer.
“Goods prices should continue to normalise, although supply-chain bottlenecks could also re-emerge if geopolitical risks escalate.”
The Federal Reserve is expected to hike rates by 25bp next week, from 4.75% to 5.0%, but stop afterwards. Jerome Powell opened the door to a 50bp rate increase in March and suggested the terminal rate for the Fed funds could be higher.
Yet, recent events, such as the collapses of Silicon Valley Bank and Signature Bank, have called into question the Fed’s ability and willingness to push rates higher to fight inflation while also guaranteeing stability.
Ducrozet said that Powell may repeat that monetary policy is working with a lag but will justify a pause in the light of recent events.
He said: “While letting inflation run might be bad, presiding over a credit crunch would be worse. Given that we have had the fastest monetary tightening cycle in history, we were expecting ‘something’ to break eventually.
“Policy normalisation was never going to be a smooth and linear process. The collapse of SVB is likely to be the catalyst that convinces central banks to proceed more cautiously going forward.”
The Fed’s focus should now turn to the timing of rate cuts, balance sheet policies and quantitative tightening (QT).
Ducrozet added: “The balance sheet runoff (QT) of the Fed’s holdings of US Treasuries and agency mortgage-backed securities should continue at the current pace for now. The Bank Term Funding Program (BTFP), aimed at providing additional funding to depository institutions, could temporarily expand the Fed’s balance sheet, but it is not large-scale asset purchases (or quantitative easing).
“If financial stresses accumulate materially, the Fed could stop QT early. However, unless the US enters a very deep recession, we don’t expect a resumption of QE [quantitative easing] anytime soon.”
Pictet Wealth Management does not expect rate cuts before 2024, but said the US will enter into a moderate recession in the second half of 2023. Inventory destocking, weak capital spending and a continued slump in residential investment should drive the contraction.