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The Feb. 14 inflation report showed that prices rose more than expected in January, which could raise market concerns over future Federal Reserve (Fed) policy and lead to continued market volatility. The consumer price index (CPI) rose 2.1% year-over-year, compared to consensus expectations of 1.9%, while core CPI rose 1.8%, compared to consensus expectations of 1.7%.1
The market’s focus is on core CPI, shown below, since it is the closest data point to the core personal consumption expenditures index (PCE), which is the Fed’s preferred measure of inflation.
All eyes on inflation
It is difficult to remember a more widely anticipated data release than this CPI report. Markets have been roiled since the recent jobs report showed that wages grew more than expected in January. Wage growth is thought to be a precursor to inflation that could incentivize the Fed to become more aggressive and pressure interest rates higher.
In our view at Invesco Fixed Income, the higher-than-expected inflation report is likely to validate investor concerns about inflation and is likely to negatively impact risk assets such as stocks and credit bonds. While another 0.25% interest rate hike is widely expected at the Fed‘s next scheduled policy meeting on March 20-21, this latest inflation number will likely raise questions about how many more rate hikes are on the horizon.
Based on our bottom-up views on various sectors, we had expected to see softness in education and health care prices, coupled with less support from housing, during 2018. So far, this has not played out in the housing sector: Rents rose 0.3% month-over-month in January, which accounted for most of the inflation gain, although price increases were broad-based overall.1 The quarterly annualized rate of inflation is now running close to 2.9%,1 which supports the possibility of four Fed rate hikes this year, in our view. However, our base case is three — revised up from two. We believe we would need to see persistent increases in inflation for four to play out, and we are monitoring this closely.
Going forward, we continue to think that housing prices will slow. However, the underlying strength in sticky core prices (including housing) could be a persistent trend. If the bond market believes the Fed needs to hike interest rates more aggressively, market volatility could pick up and risk assets could come under pressure.
1 Sources: Bloomberg L.P., Feb. 14, 2018, and Invesco
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Past performance is not a guarantee of future results.
The consumer price index (CPI) measures change in consumer prices as determined by the US Bureau of Labor Statistics. Core CPI excludes food and energy.
The personal consumption expenditures (PCE) index measures price changes of consumer goods and services, and is issued by the Bureau of Economic Analysis.
James Ong, CFA
Senior Macro Strategist
Derivative Portfolio Manager
James Ong is a Senior Macro Strategist and a Derivative Portfolio Manager for Invesco Fixed Income (IFI). Mr. Ong contributes economic and market analysis to the Macro Research platform. Mr. Ong leads IFI derivative strategy and oversees derivatives held in IFI portfolios.
Mr. Ong began his investment career in 2001. Prior to joining Invesco in 2014, he was a senior vice president, a senior portfolio manager and a senior trader at Hartford Investment Management Company.
Mr. Ong earned his BA degree in economics from Middlebury College. He is a CFA charterholder.
Noelle Corum, CFA
Invesco Fixed Income
Noelle Corum joined Invesco Fixed Income in August of 2010 and is involved in derivatives, FX and rates trading, macro view implementation and asset allocation.
Ms. Corum began her investment professional career at Invesco following her undergraduate studies.
She earned a BS degree in business administration, with a concentration in financial analysis, from Saint Louis University, where she minored in mathematics and earned a certificate in service leadership.