Hopes for a further decline in U.S. inflation this year are giving way to a risk seen in some corners of the financial market that any improvement in price gains will turn out to be fleeting.
Strategists at JPMorgan Chase & Co.
JPM,
and BofA Securities, along with Peter Schiff of Euro Pacific Asset Management, are among those who have attached recent signs of disinflation to the word “transitory,” borrowing the phrase used by Federal Reserve officials in 2021 to describe inflation and which turned out to be wrong. Inflation, as measured by the headline annual rate on the consumer price index, has been on a steady decline for six straight months — falling to 6.5% in December from a 9.1% peak in June.
Friday’s blockbuster data — which showed that the U.S. added a stronger-than-expected 517,000 jobs in January, despite a string of eight Fed interest rate increases since last March — has thrown an unexpected kink into the narrative of steadily declining inflation. In the past two days, three Fed officials, including Chairman Jerome Powell, have said the central bank needs to raise rates higher, while traders adjusted their expectations toward the greater likelihood of a 5%-plus fed funds rate by May.
“This is the only story for 2023: transitory disinflation,” said Gang Hu, a trader of Treasury inflation-protected securities at New York hedge fund WinShore Capital Partners. “The labor market is very tight and this makes the inflation story very, very complicated.”
“Transitory means a shorter period of disinflation. We are fairly sure we are going to have disinflation for five to six more months, but are not sure what’s happening after that,” Hu said via phone. “Money will come in from the sidelines, which is what we saw in January, and assets won’t sell off if the market holds the view that there will be a reasonable long-term period of disinflation. But I see a 70% likelihood that we are going to have more inflation problems down the road,” driven in part by higher energy costs out of Europe.
Financial markets turned their attention on Tuesday to comments by Powell, who reiterated that the U.S. is in the early stages of disinflation and said the process is going to take quite a bit of time. He also said that January’s strong jobs report underscores the “significant road ahead” for the Fed in getting inflation down, and it’s possible policy makers may “have to do more.”
All three major U.S. stock indexes
DJIA,
SPX,
finished higher in volatile trading after Powell’s remarks. Meanwhile, Treasury yields also ended the New York session higher, with the policy-sensitive 2-year rate
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carving out a fresh two-month high.
In a note released Monday titled “Transitory Disinflation?,” JPMorgan strategists Marko Kolanovic, Thomas Salopek and others indicated that companies face the difficult choice of either laying people off or seeing their margins worsen, and right now “we continue to be on a path toward worsening margins, which will eventually produce layoffs.”
“So disinflation in this situation will not be anything to celebrate, as it leaves rates in an even more restrictive state with central banks slow to change course unless a risk event forces a reset,” they said.
Over at BofA Securities, strategist Michael Hartnett and others wrote last Thursday that they see a “bear risk” that disinflation in the first half of this year “proves ‘transitory’ and/or ‘no landing’ in H1 [the first half] flips to ‘hard landing’ H2 [the second half].”
Much is riding on getting inflation just right, with hopes for a markets recovery from 2022’s dismal performance in stocks and bonds hingeing on a big drop in inflation. Dan Eye, chief investment officer at Pittsburgh-based Fort Pitt Capital Group which oversees $4.5 billion, is one of those who says that the recent decline in inflation “is real.” He said his firm has doubled its exposure to energy stocks, “the best inflation hedge,” but is keeping a balanced approach by holding onto large-cap value and technology stocks.
“We’re seeing a huge rollover in the money supply, which is going to help with inflation, and haven’t seen a wage-price spiral yet,” he said. “I do think we’re going to head toward more normal levels of inflation of 3% or 3.5% by the end of 2023, and don’t think the recent declines will turn out to be a head fake.”
The next major U.S. inflation update will come on Feb. 14, when the January CPI report is released.
