In terms of inflation, it has been five years since either headline or core consumer price inflation were at or below the 2% target, and higher fuel and airline fares mean CPI looks set to break back above 4% imminently. The Federal Reserve can’t do anything to ease the current energy supply shock though. Instead, its focus is to ensure that inflation expectations remain contained and, for now, that seems to be the case. Hence the mildly hawkish rhetoric coming from officials.
Importantly, the current supply shock, focused on fuel prices, is not as broad as the pandemic-related supply chain stresses in 2020/21, and we don’t have the same sort of demand impetus that would risk a broader, more persistent inflation story.
Real household disposable incomes are already flatlining, so we see higher fuel prices as being demand destructive via reduced spending power. This is set to weigh on core inflation, and we also need to remember the importance of shelter costs within the US inflation basket (35.5% weighting for headline and 44% for core), which we expect to moderate further. Moreover, if Middle East tensions ease and oil prices drop back to below where they are today, there is a high probability of sub-2% year-on-year inflation being achieved in 2027.
In terms of jobs, there are only 260,000 more people in work today than 12 months ago, implying that the jobs market has effectively stalled during a period when the US growth story was robust. Our concern is that with the Middle East tensions showing little sign of coming to an imminent conclusion, an overlay of heightened geopolitical, economic and market angst is not going to incentivise business to suddenly start hiring now. In fact, with cost pressures rising and consumer spending power being squeezed, corporate profitability will face more challenges and runs the risk that employers will look to cost containment measures. This threatens weaker payrolls numbers in the coming months.
The Federal Reserve has to optimise monetary policy for two very different goals – inflation and jobs. It still views the current stance of monetary policy as being modestly restrictive. With a new, more dovish Fed Chair taking office and key elections this year, which will keep up the political pressure for action, we look for September and December Fed cuts.