The stock market rebound driven by the election of President Trump will put upward pressure on the inflation indicators favored by the Federal Reserve, which in turn may lead to interest rates being maintained at higher levels.
The surge in stock prices after the election will lead to increased costs for portfolio management and investment advisory services, which is a category in the PCE price index that largely follows market fluctuations. Changes within this category will directly affect the Federal Reserve's policy decisions, as they impact a broader service sector inflation indicator that officials closely monitor.
Service sector inflation has been a relatively stubborn component within the overall PCE index, with markets expecting data to be released on Wednesday showing that the overall PCE index rose 0.2% month-on-month and 2.3% year-on-year in October. Employ America Executive Director Skanda Amarnath estimates that the so-called 'stock market effect' accounts for more than one-third of core service sector inflation compared to pre-pandemic trends.
Amarnath stated, 'Either the stock market must correct, or the Federal Reserve will be forced to slow down the pace of interest rate cuts and take a slightly hawkish stance. If the stock market corrects more this month, then many things will become much easier.'
On bets that Trump would win, the S&P 500 index rose before the presidential election on November 5 and continued to hit record highs after Trump's victory, as investors flocked to what is known as the 'Trump trade'—betting that the elected president will implement business-friendly policies after returning to the White House in January.
Economists have gained a fairly good understanding of the data in the portfolio management category within Wednesday's data, as the PCE uses raw data similar to another monthly government report on producer prices, which showed that portfolio management fees rose 3.6% month-on-month in October, the largest increase in six months.
This component was introduced into government price analysis in the early 2000s. It is based on changes in income earned by mutual funds and asset management companies for providing investment advice. Since well-performing stocks mean asset management companies charge higher fees, this category tends to reliably track the stock market, albeit with about a month’s lag.
This component accounts for about 1.5% of the overall PCE basket, which is not much, but it is sufficient to influence results when the market experiences significant fluctuations.
Bloomberg economists Eliza Winger and Estelle Ou wrote in a report last week that stock market momentum 'may continue to be a persistent source of inflation under expectations that the business environment under the Trump administration will be more accommodating next year.'
Federal Reserve officials stated that as long as the labor market remains strong and the economy continues to grow robustly, they are not in a hurry to continue cutting interest rates.
Although Trump's agenda may be favorable for business, concerns about whether it could reignite inflation may be another reason for the Federal Reserve to remain cautious.
Citigroup economist Veronica Clark said that regarding the risk of rising inflation due to the stock market rally, policymakers may know to ignore recent volatility. Clark stated, "You don't necessarily have to ignore it. However, Federal Reserve officials should be less concerned about this part's strength, partly because it is very unstable, so it will revert at some point."
Article forwarded from: Jinshi Data
