Investment Perspectives: US inflation & the pursuit of Goldilocks

07 May 2024

Investment Perspectives: US inflation & the pursuit of Goldilocks

Since 2012, the Federal Reserve has targeted an inflation rate of 2%. Keeping inflation low is one of the Fed's dual mandate objectives, along with stable and low unemployment levels. Central banks have a degree of independence, but central bankers talk to each other, and US monetary policy can affect and lead other parts of the world.

What does inflation in the US mean for the investment world? Inflation can undermine the performance of an investment, the value of an asset, or the purchasing power of a stream of income, but several asset classes perform well in inflationary environments such as real estate and commodities.

Consumer Prices Index (CPI) is a measure of the average change over time in the prices paid by urban customers for a market basket of consumer goods and services and is one of the most important economic indicators. In March 2024, US prices had increased by 3.5% compared to March 2023 according to the 12-month percentage change in the CPI. Inflation readings towards the end of 2023 were lower than expected but since then, inflation has made a comeback with readings rising for three months in a row during the first quarter of 2024.

Core inflation, excluding volatile food and energy prices, was up 0.4% in March from the previous month and 3.8% from a year ago. Food prices increased by 0.1% month on month and were up 2.2% compared to last year. US producer prices rose in March from a year earlier at the fastest pace in nearly a year, offering more evidence that progress in bringing inflation down may have stalled and raising doubts about whether the Federal Reserve will start to cut interest rates. Energy prices also saw an uptick of 1.1% month on month and 2.1% over the past 12 months. So, what’s been happening?

The housing component of the CPI in the US is around a third of the basket and is exerting upward pressure on the inflation reading. The PCE (Personal Consumption Expenditures) is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behaviour. PCE is the Fed’s preferred measure and reduces the housing weight in the basket to around 14%, yet that is also rising against expectations.

What impact does housing have? Housing demand remains strong in the US, especially when it comes to newly built housing. The US population is avoiding making changes to their low-rate mortgages causing the inventory of existing homes to dry up. Higher interest rates haven’t yet impacted a large proportion of homeowners which has helped to sustain demand in the US economy.

What’s happening in the oil market? A sustained effort by OPEC to reduce supply has seen cuts to production across the group, as well as from Russia. This has served to balance the market but a greater demand than forecast has meant that prices have recently been creeping up. Transport costs in inflation readings across the world have been impacted and there are projections that the price could push higher due to greater global demand and the upcoming US summer driving season.

The latest PCE inflation rate is 2.8%, 0.2% above the forecast, with housing and energy both contributing to the increase. Oil prices are higher than they were at this point last year and the forecast demand picture by both the International Monetary Fund (on a continued positive global growth scenario) and OPEC, will likely underpin higher oil prices. Car insurance, unusually, has also been contributing to a rise in PCE and is keeping inflation sticky.

The inflation outlook is likely to be choppy which presents opportunities for investors to capitalise on a potentially higher inflationary environment. Predicting changes in interest rates is far from straight forward, but investing in selected funds based on indicative market data can give the investor the potential to capture prolonged inflationary trends. Considering asset classes known for resilience during inflationary periods, such as real assets, including infrastructure, real estate, commodities, and natural resource equities, could also be advantageous. And a combination of these assets in a portfolio can offer better risk-adjusted returns for investors.

The inflationary outlook is proving stickier than anticipated, but investors have options of how to tactically allocate within portfolios to capture returns in an unsettled market environment. Embracing uncertainty alongside relevant, considered positioning are crucial for success. 

Naeem Siddique, Investment Research Manager

Katie Sykes, Client Engagement & Marketing Manager

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