According to Charles Schwab, the Fed's task of cooling prices may encounter some obstacles, and there are some signals that the market needs to pay attention to regarding this risk.
Strategists at this brokerage firm predict that the downward trend of inflation will be a 'bumpy road' although it is generally cooling. In a new note, the team of strategists pointed out that some pressures in the US economy could cause prices to rise again.
'We believe that inflation will continue its downward trend, but there are some potential risks in the future, including the Fed lowering interest rates, stronger-than-expected economic growth in recent months, and some policy proposals from President-elect Donald Trump,' the Charles Schwab strategists said.
Specifically, tariffs will drive the upward price trend as the cost burden is shifted from importing companies to consumers. Similarly, tax cuts as proposed by Mr. Trump could provide additional momentum for economic growth.
Meanwhile, the Fed may face obstacles in its goal of bringing inflation back to 2%. According to the Bureau of Labor Statistics, the US CPI rose 2.6% year-on-year in October, matching estimates but higher than the previous month's increase of 2.4%.
Strategists point out several factors that pressure efforts to cool inflation:
Labor costs are rising.
According to Fed data, labor costs have surged in recent months as business labor costs increased by 3.4% compared to the same period last year in Q3. Higher wages are seen as inflation because this factor increases costs for businesses and may lead them to raise product prices, known as the wage-price spiral.
According to strategists, it is still too early to assert whether this upward trend will continue, but if the labor supply remains scarce and puts pressure on wages, the rate of increase in labor costs will accelerate, thus causing inflationary pressure.
The correlation between stocks and bonds.
The stock market often moves in the opposite direction to bond yields, as expectations of higher interest rates negatively affect stock prices. The 120-day correlation indicator between the S&P 500 and the 10-year US government bond yield has turned positive, meaning that stocks and yields are rising in tandem as the market expects strong economic growth.
Strategists say that if this correlation turns negative, it will signal greater concerns about inflation in the economy. Accordingly, this development will put pressure on the stock market. It is still too early to assert, but this risk will become clearer in 2025.
US government bond yields are rising.
Government bond yields have risen since Mr. Trump won the presidential election. The yield on 10-year government bonds exceeded 4.4% after the election results were announced, the highest since early July.
This development reflects the market's expectation that interest rates will rise sharply. This is a sign that investors are concerned about future inflation pressures.
The growth momentum of the economy is strengthening.
The US economy seems to be growing better than investors expected. According to Schwab, this is another factor that could drive inflation. The Citi Economic Surprise Index, the difference between reported economic data and forecasts, has surged in recent months, from around -50 in the summer to 40 in November.
Strategists state: 'Stronger growth will prevent the Fed from lowering rates as much as previously forecasted in the coming months. Another factor affecting the Fed's policy adjustment path is the risk of higher inflation.'
The group forecasts that the Fed will continue to lower interest rates in the coming months if inflation continues its downward trend. However, this path will be slower and less robust in 2025 compared to just a month ago. According to CME's FedWatch tool, the likelihood of the Fed pausing its rate-cutting cycle in December has increased to 42%, compared to 14% a month ago.
Refer to BI
