Allianz chief economist Mohamed El-Erian said that despite the sharp decline in the US inflation rate over the past year, the monthly data release on price changes in the United States continues to attract a lot of attention, and its influence goes far beyond the scope of economists and market participants. These data shape people's views on economic growth prospects, central bank policies and market performance, and also have social and political impacts.
El-Erian pointed out that the data has already sent out warning signals. Data released last week showed that the overall inflation rate in the United States rose from 3.1% to 3.4%, exceeding the market consensus forecast of 3.2%. This means that inflationary pressure has intensified, which may bring new challenges to the Fed's policy making and attract more attention and discussion at the economic, market and policy levels.
The U.S. economy has led the decline in overall consumer price inflation in developed countries after inflation peaked at 9% in 2022. Surprisingly, this significant pullback in inflation has not hampered growth or employment. The U.S. economy continues to demonstrate strong international competitiveness, growing by nearly 5% in the third quarter of 2023, and according to market consensus forecasts, growth will exceed 2% in the last quarter of the year. At the same time, the unemployment rate remained at a low 3.7%, monthly job creation was impressive, and weekly initial jobless claims also remained low.
This unique combination solidifies the consensus for a very modest soft landing for the economy. It is the main reason why the market is pricing in a doubling of the 0.75 percentage point rate cut (starting in March) that Fed officials have hinted at, while analysts predict a continuation of last year’s impressive rebound.
This economic situation also brings hope to the Biden administration. Voters will gradually forget the unexpected inflation shock and pay more attention to recent real wage growth, strong job creation and legislative measures to support future economic growth and productivity improvements, which will help the government win public support for its economic policies in the next election.
El-Erian said: "Before Thursday's data release, a cautious attitude was necessary in the final stage of the 'battle on inflation'. Given the latest data and recent geopolitical developments, there is even more reason to be vigilant now. These factors may bring new variables and challenges to the prospects of a soft landing for the US economy, the direction of the Fed's policy and its impact on market expectations."
In order to quickly achieve the Fed’s 2% inflation target, the service sector needs to accelerate the process of disinflation to match the trend of continued slowdown (or even absolute decline in some cases) in commodity price growth. This task is made more difficult by the so-called base effect.
Data released last Thursday showed the enormity of the task. Although core inflation fell slightly from 4.0% to 3.9%, it was still above market expectations of 3.8%. At the same time, the current data do not yet reflect existing cost pressures. The disruption to Red Sea navigation will affect inflation directly, by raising input and final goods prices, and indirectly by delaying the supply of goods. In addition, the economy will have to deal with rising labor costs. These factors all point to considerable challenges in achieving the Fed's 2% inflation target.
El-Erian believes that "the impact of inflation on economic growth depends largely on whether the Fed is willing to tolerate inflation above the 2% target for some time." At present, maintaining the implicit inflation target close to 3% poses less risk to economic and financial stability. In fact, in the current period of relatively inelastic global aggregate supply, such an approach is reasonable, because the environment we are facing now is the opposite of the insufficient aggregate demand that prevailed in the decade after the 2008 financial crisis, and it is a new stage that may last for several years.
"Financial markets need to realize that the Fed's guidance on cutting interest rates by 0.75 percentage points starting later this year is more reasonable than the current market pricing." For investor strategies, this means that when investing, more attention should be paid to the selection of individual stocks (rather than passive index investment) and to a sound investment structure and a solid balance sheet. In short, investors should adopt a more refined and prudent investment strategy to cope with changes in the future market environment based on the expectation that the Fed may not overly loosen its monetary policy.
“A quick return to our 2% inflation target was never going to be easy for the U.S. economy, especially given the Fed’s early missteps in both its analysis and its policy response.”
The article is forwarded from: Jinshi Data