The latest data shows that US core personal consumption expenditures (PCE) increased by 0.6% in January, marking the second consecutive month of growth. This development confirms that inflation is not slowing down, and is in fact winning its battle against the Federal Reserve. The rise in PCE is particularly concerning as the Fed had already been working hard to aggressively raise rates. The year-over-year number, a favorite of the Fed, rose to 4.7%, well above the expected 4.3%.
This trend is particularly alarming when considering that the core number doesn’t even include gasoline prices, which are also on the rise. As these prices continue to increase, they will eventually lead to higher prices for all goods and services. The Fed is now losing the battle against inflation and will need to take even stronger action than originally anticipated.
According to recent forecasts, the Terminal Rate for this Fed raising cycle is anticipated to range from 5.75%-6.5% and may risk going up to 7.5%. A rate above 6% is now being taken seriously by economists as a plausible outcome. The risk scenario of widespread inflation leading to an upward prices/wages spiral is becoming increasingly likely, which could result in a persisting hiking cycle throughout the year.
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This could lead to further declines in US stocks and property, and a more significant economic slowdown in general. It could also result in another alarming and spectacular rally in the value of the US dollar. While the US economy may eventually fall back into the global pack, this may not happen for some time. In the meantime, the US dollar is likely to continue its upward trend.
It is clear that the resilience of inflation at these rate levels is and will continue to catch the market by surprise. This reinforces the view that a defensive stance on stocks and property is warranted, while looking for opportunities to buy the US dollar at a low. The Federal Reserve will be hiking rates for a long time to come, and any suggestions of a resurgent US economy are likely to be short-lived.
