INSIGHTS

Financial Industry Insights from Advisors Asset Management

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Inflation is Dead. Long Live Inflation.


Let’s just say it: inflation is dead.

We have suggested as much, many times over the last few months. We’ve discussed how media/prognosticators have mismeasured inflation using stale information when calculated on a year-over-year basis. And we have discussed how shelter inflation has gotten calculated incorrectly, giving a misleading view of where inflation stands; but we are saying it more directly now: “The Fed’s preferred measure says inflation is dead.” Not forever. It might bump around for a while on the way down. It might not consistently stay at or below the Fed target. And it can still get jolted by idiosyncratic events, especially in a world of heightened geopolitical risk. But the supply-driven inflation of the pandemic era has died. What happens now?

Requiem For a Nuisance

The Fed’s preferred inflation measure, the core personal consumption expenditures (PCE) index, is screaming that inflation has ended. Other measures of inflation will continue to show different, frequently higher, rates. But the Fed uses the target rate of 2% on the core PCE, and by that benchmark the data looks clear. On one-month and nine-month annualized bases, core PCE sits a bit above the target rate. On three-month and six-month annualized bases, it now sits below target. The year-over-year rate, which we have roundly criticized because it uses stale data, still clocks in at 2.9%. Yet even that metric has fallen to its lowest level since March 2021. It remains closer to 3% because of relatively high inflation readings from January, February, and March of 2023, roughly a year ago. But inflation has slowed considerably since then and those readings will fall out of the calculation during the first quarter and likely get replaced by lower monthly rates. That means — simply by dint of mathematics — the yearly rate should move closer to target over the next quarter or two. And ultimately, other major inflation indexes, such as the consumer price index (CPI) and producer price index (PPI), will follow and head closer to the Fed’s target.

core pce inflation

The Economy Is Alive and Well

Despite slowing inflation, the economy thrived during the fourth quarter. Real GDP growth registered 3.3% annualized, well ahead of expectations. That caused 2023 to come in at 2.5%, also well ahead of expectations and a significant acceleration from 2022’s 1.9%. Growth could have been even stronger if not for the auto strike which reduced quarterly growth by 50 to 100 basis points (bps). The economy got stronger, not weaker, as the year progressed. Data for personal income and spending in December reinforces this view, but we expect that the economy cannot sustain such febrile growth. As more signs of slowing occur, that should provide the Fed with enough evidence to start cutting rates, likely around mid-year. At a current target rate of 525–550 bps, the real Fed Funds rate remains positive, sitting well into restrictive territory. We estimate the nominal neutral rate at roughly 275 bps, giving the Fed a lot of room to cut. The longer rates stay elevated, the more collateral damage they can do. The Fed can now safely provide the economy with a shot of adrenaline to keep its heart beating vigorously.

What To Watch This Week

A data and information deluge are coming. The Fed is meeting this week. We expect no change to the Fed Funds rate, and we will not get an updated forecast, but we will look for any signs as to Fed thinking on the future path for the Fed Funds rate. Employment growth likely slowed in January, with the unemployment rate holding fairly steady. Increases in minimum wage in 22 states should put some upward pressure on average hourly earnings. But the employment cost index for the fourth quarter should show some slowing. Open jobs for December should remain elevated with the ongoing labor shortage. Strong fourth quarter GDP growth should mean another solid gain in productivity. Lastly, consumer confidence for January should take another step up while the final reading for consumer sentiment for January should hold from the preliminary reading.

Commercial Real Estate Implications

If you’re looking for an early green light for commercial real estate (CRE), it is now flashing. Although there are never any guarantees in economics, the outlook we published and discussed just last week is already coming to fruition. Inflation has effectively returned to target, the Fed is done cutting rates and shifting into an easing stance, the economy still carries notable momentum, and space market fundamentals generally remain firm. Capital markets remain the last piece of the puzzle, but their time is coming, likely sooner than later. Even if the economy slows faster than we forecast, that will provide the Fed with more fodder to cut rates, which could more than offset any deterioration in fundamentals from any potential economic slowdown. The road ahead is starting to open up…who’s ready to drive?

 

CRN: 2024-0104-11340 R


This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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